What is the difference between a chit fund and a mutual fund?

The idea behind any investment is to get more than we initially invested. We hope that the generated profits will come in handy in times of need. An ideal financial plan should be based on the investor’s financial goals and risk appetite. So, the investment tools also vary according to one’s profile and objective.

It is important to diversify your portfolio with different asset classes. Both Mutual Funds and Chit Funds pool money from investors, albeit for different reasons. In a mutual fund investment, the fund manager invests the pooled money in securities such as stocks, bonds, etc. In a chit fund, the pool of investors is usually small and the group shares a common purpose. Mutual funds come under the purview of the regulatory body, SEBI. However, a chit fund is usually managed by a mutually decided head person or foreperson

How does a Chit Fund work?

Chit funds are usually started by a small group of people who share common characteristics. The members could be people in the same business, residents of a housing society, relatives, etc. It is more prevalent in non-urban areas. The objective of such a fund is both saving and borrowing. A chit fund is a rotational scheme where each member contributes a fixed sum periodically (usually monthly). The duration of the scheme is pre-decided. In most cases, the number of months for which the scheme runs is equal to the number of subscribers.

Once the money is collected from the subscribers every month, an auction or lucky draw is held for the pooled amount. In a lucky draw, the person whose name comes up gets to take home the pooled amount after subtracting the organizer’s fees and commission. In the case of an auction, the subscriber who bids the lowest value for the sum takes home the amount after subtracting the organizer’s fees and commission. The difference between the pooled amount and the bid amount is distributed equally among the members.

Types of Chit Fund

Registered Chit funds: These are registered with registered firms of societies and chit funds and are regulated by the RBI. These funds are part of the Chit funds Act 1982 and are available across all the states of India.

Unregistered Chit Funds: These are not governed by any Act and are usually operated among friends, families, and acquaintances.

Online Chit Funds: These are similar to unregistered chit funds but are operated online. They may carry fraud risks as the subscribers in the group may not know each other.

How do Mutual Funds Work?

Mutual funds are professionally managed investment tools that invest money pooled from investors in securities such as stocks, bonds, etc. Common mutual fund types are equity funds. Debt funds, liquid funds etc. These are managed by an Asset Management Company (AMC). Fund managers who manage the corpus have sound knowledge of the markets.

Difference between Mutual Funds and Chit Funds

Although both mutual funds and chit funds work with pooled money from investors/ subscribers, the characteristics, objectives, and working vary greatly.

	Mutual Fund	Chit Fund
Objective	Capital appreciation through returns on investment.	Short term borrowing and saving.
Operated by	Knowledgeable and experienced fund managers appointed by an Asset Management Company (AMC).	Operated by Knowledgeable and experienced fund managers appointed by an Asset Management Company (AMC) Generally, the fund is managed by a mutually decided upon headperson or foreperson.
Expenses/Commissions	AMCs usually charge 2-3% as fund management charges.	The organizer of the fund may charge 5% or more for services provided.
Growth Opportunity	Growth Opportunity Offers growth opportunities for your money based on market conditions.	It doesn’t offer any return or interest on the money.
Documentation	For first time investors, the KYC process could be extensive.	Minimal or no documentation.
Regulatory Body	Regulated by SEBI	Registered chit funds are regulated by the Registrar of Chits appointed by respective state governments under Section 61 of Chit Funds Act 1982.
Market Risks and Volatility	These perform with accordance to market conditions. There is no guarantee of the principal amount.	Not exposed to the market, hence free of any market risk.
Taxation	Dividends and earnings are taxable.	Generally non-taxable but must be declared.

Conclusion

Both chit funds and mutual funds are investment tools that serve different purposes. Chit funds have earned a bad reputation with the discovery of frauds. However, registered and regulated chit funds continue to be a good microfinance source, especially for people in non-urban areas. Always do your due diligence and choose wisely an investment route that matches your goals, objectives, and risk profile.