Is Chit a good Investment option? – PrognoAdvisor

Is Chit a good Investment option?

There is a trend to subscribe to chit fund schemes. I know a person who is crazy about chits. He joins a chit, successfully bids and deposits the bid amount with the chit company for interest of 9%p.a. He uses the monthly interest to pay the installment for another chit. He feels that he will get higher than bank returns by doing so. But it is not true.

Though the deposit will give 9% interest and there will be dividends, when he wins the bid he gets an amount much lesser than the sala. Therefore the extra returns will get adjusted and effectively the returns will be similar to bank interest rate.

This chit strategy will lead him to a bigger issue. He will not be able to take off his money when he needs unless all installments are fully paid. But in case of a bank RD account he can close the account any time.

Chit schemes are more like loan products and less like savings schemes. They are good for people who find it difficult to get bank loans. But a salaried person will not have any problem in getting a cheaper bank loan.

There is a way to make extra returns from chits. There are people who default on chit payments. After paying a few installments, they stop paying the installments. They will not get any money back normally unless someone else takes over their place by paying out the entire due amount. So a smart investor can take over the membership from a defaulted member by paying him a portion of the payments he has already paid and repaying all the dues.

Let us assume that there is a KSFE chit having sala of Rs.1 lacs. It has 20 installments of Rs.5000 each. Joseph paid Rs.4500 per installments for 5 installments and stopped paying. He did not have to pay Rs.5000 in the initial months as the installment was net of dividends. Now his dues have piled up to Rs.28000 as 11 months have passed since the chit started. He will not get the Rs.22500 he paid unless somebody takes over his membership. Sunil comes forward and tell Joseph that he will take over the chit. He will pay Joseph Rs.16000 and the chit fund Rs.27500. Totally he has invested Rs.43500. Let us assume that he bids next time and get Rs.90000. He deposits the money with the fund for the remaining 8 months and gets interest of 8%p.a. He will be paying about Rs.45000 over 9 installments. By the time the chit closes he might have paid about Rs.88500 in total. He will get about Rs.94,738 as deposit maturity value. If IRR (internal rate of return) is calculated then it is as good as getting 12.75%p.a. returns.

The profitability depends upon the amount of discount you can get from the first member and the number of installments left.

Sanjeev Kumar Gopalakrishnan

Sanjeev Kumar G, an IBS Chennai Alumni, is a Certified Financial Planner (CFP) from India, since 2005. He has 22 years of experience and is an expert in various personal finance areas like portfolio construction, investment research, life insurance and financial planning.

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