India is a nation of extremes, with the rich on one end and the poor on the other. With liberalization the median income of the people has increased significantly, however the income disparity has also increased. This has given rise to many get-rich-quick schemes sprouting out in the market. One of them is the chit fund scheme. However it is very prone to frauds due to poor documentation and lack of information available on them. These investment scams usually prey on the poor and the lower middle class who do not have the necessary knowledge to separate legitimate schemes from frauds, and even then they can be fooled if the scam is complicated enough. In this post I’ll discuss the common indicators of a chit fund scam and how to build a better investment portfolio without resorting to such measures.
What is a Chit Fund?
A chit fund is an investment scheme where the subscribers pool investments into a common pot every month. Then an open auction is held where the lowest bidding subscriber takes winnings from the pot that month. The rest of the money is distributed to all the other subscribers, minus the distributor’s fees. Then the cycle is continued to next month and so on. This is a very old method of investment, the earliest mention being William Logan of the Malabar district of the Madras Presidency (1886). However the risk to investors is very great, due to sparse documentation.
Signs To Look Out For
- High rate of return: If it looks too good to be true, it most probably is. Any rate of return higher than 8-10% is suspect. No fund is going to give a 30% return of investment, if they want to last long.
- Stoppage in payment: If returns are stopped for any reason, it is time to look closely at the fund.
- Notices by government bodies: If notices are issued on the fund for suspect transactions, get out immediately. It is usually a sign that the investment is not sound.
- Excessive endorsements: Celebrity endorsements are not a bad thing but if it looks like everyone is praising a chit fund, it means they have a stake in it too. They are human too, so they can also make mistakes. Tread carefully in such cases.
Chit fund scams usually target people of the lower income group, who do not have good enough assets to be considered for credit from banks. These people do not have the knowledge on how to tap into the investment market and most probably are too far away from any reputed banks. The returns would come regularly for a few months and then stop suddenly. Then it would be found out that the organizer/distributor has fled with the pot and both investors and agents are left in the lurch.
Precautions You Can Take
If you think that chit funds are for you then there are a few precautions you should take.
- Check if the chit fund is registered. Government registered funds are under scrutiny and therefore cannot divert your investment to other companies at their whim. You can do this by looking at the certificate and registration number of the chit fund in the state it operates in.
- Check the promoters of the fund. If the promoters of the fund are financially sound then there is less temptation to dip into the fund.
- Do not default on a payment. You should be ready to contribute to the fund through the whole cycle. Penalties for default can be exorbitant.
- Check if the fund has complaints against it. Complaints by government bodies on the fund is not a good sign. Exit immediately. You can check this at the registrar of chit funds in the state.
- Choose the fund with the lowest commission. The distributor/foreman takes a commission for disbursing funds to distributors. Compare different chit funds to find out which takes the least commission.
The Oscar Group of Companies started a chit fund in 2010 in Odisha, West Bengal and Gujarat. It was not registered in the government as a chit fund and was promising to double the investment in three years. It also had endorsements from Ollywood actors and politicians. The signs of the scam were there from the beginning but no one noticed.
In 2015, the Directors closed the offices amidst complaints by investors and agents for non-payment of interests as well as return of deposits. It turns out that the directors had embezzled about ₹130 crore into other companies and had absconded. Thousands of families were left destitute and agents were run out of villages with their families for their association with the scam. Thankfully, all the accused have been caught but the money will probably never be seen again.
If you have money you want to invest, never go for chit funds as the risks are very high, even with government issued chit funds and even registered ones and returns are variable. The better vehicle for your investment would be a post office account. Even if the rate of return is small, your investment will be safe. For those who want to go for more, investing in savings bank accounts will be better, or even fixed deposits. Only those with good appetite for risk and better knowledge of the market should go for instruments like mutual funds.
I hope this post was informative enough for you to understand the dangers of chit funds. Keep an eye open for more posts on this topic soon.