Mutual Funds vs Chit Funds: Understanding the Differences

India has a versatile array of investment instruments for all its citizens to benefit from. In this regard, chit funds and mutual funds are two popular forms of investment schemes that serve different financial needs and goals. Learning their structure, benefits, and risks can help you make informed decisions about which one to go for, and why.

Chit funds are a type of unregulated investment option that has been part of India's financial fabric since the late 1800s. They are a form of rotating savings and credit association where a group of individuals come together to contribute a fixed amount every month. Each member has the opportunity to receive the total sum once during the scheme's tenure, either by lottery or through an auction system.

• Mutual funds are SEBI-regulated and safer, while chit funds are often unregulated and riskier.
• Mutual funds offer market-based returns through diversified investments, whereas chit funds provide fixed returns through a savings-bidding model.
• Mutual funds have high liquidity and professional management, while chit funds have restricted liquidity and higher scam risk.

To understand how such chit funds operate, let us consider an example. Let us say, 10 people come together to form a chit fund contributing Rs. 10000 every month for a period of 10 months. This creates a total pool of Rs. 100000 every month. In the first month, everyone who had invested in the fund initially can bid to withdraw the amount. In this case, the person who bids the lowest wins the payout.

For example, in the above situation itself, let us assume that the lowest bid made was for the amount of Rs. 75000. So, while the person with this bid wins the stated amount, the difference between the total pool and the withdrawn amount, that is, Rs. 100000 - 75000, or Rs. 25000, will be equally distributed among the other investors. This process continues every month until each member has had their turn. Moreover, the organiser who manages the fund takes a commission of around 5-10% as well.

A few of the most well recognised chit funds in India include the following:

• Mysore Sales International (Government of Karnataka)
• Kerala State Financial Enterprise (Government of Kerala)
• Shriram Chits (Shriram Group)
• Margadarsi Chits (Ramoji Rao Group)

Chit funds provide easy access to credit for investors dwelling in smaller towns or with limited access to banking facilities. Yet, they come with some associated risks particularly when they are not transparent or regulated.

Mutual funds are a type of investment vehicle that works by pooling in money from multiple investors to invest in a diversified portfolio of stocks, bonds, and other such securities. These funds are managed by expert fund managers, and governed by the Securities and Exchange Board of India which ensures greater transparency and regulation. Mutual funds are one of the most prominent modes of investment in the Indian industry today.

Mutual funds work quite differently as compared to chit funds. In this respect, investors purchase units of a mutual fund that represent a part of the total underlying assets of the fund. The fund manager then invests this pool of money into an array of securities according to the specific fund’s investment objectives. You can earn returns based on the mutual fund’s performance in the long run.

These are a few of the types of mutual fund schemes available in the market today:

• Equity funds: These mutual funds have at least 65% of its total assets invested in equity stocks of listed high performing companies.
• Debt funds: Such funds focus at least 65% of its total portfolio on fixed income securities such as government bonds and corporate bonds.
• Hybrid Funds: These are a new type mutual fund scheme that mix both equity and debt for balanced risk and return.

Mutual funds and chit funds both have their own pros and cons. The following table compares their key features and benefits:

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