There is a famous saying “Look before you leap”. Your money is yours, only as long as it remains in your pocket. You need to be very careful while making an investment. If your money goes in the wrong investment, you might never see it again. “The art is not in making money, but in keeping it.” Find an investment giving returns too good to be true? Warning bells should ring immediately in your head. We at IndianMoney.com will help you make wise investment decisions. The team of wealth doctors at IndianMoney.com is always there to help and guide you. All you have to do is give a missed call on 022 6181 6111 to explore our unique Free Advisory Service. IndianMoney.com is not a seller of any financial products. We only provide FREE financial advice / education to ensure that you are not mis-guided while buying any kind of financial products.
You need to first understand the difference between a regulated financial instrument and an unregulated financial instrument. A regulated financial instrument is answerable to a regulator, such as RBI (Banking regulator) or SEBI (Capital market regulator). It has to follow, set rules and guidelines. What’s the benefit of investing in regulated financial instruments? Your money is safe. Your investments have a safety net. Agents of a regulated financial instrument cannot run away with your money. If you invest your hard earned money in an unregulated financial instrument, you do so at your own risk. Their agents and promoters are answerable to no one. They could disappear with your money.
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You have heard of this highly popular saving and investment tool called the chit fund. It is highly popular in India and is known as chitty or kuree. Chit funds have been in the news for all the wrong reasons. While an investment in a registered chit fund of good repute is quite safe, you need to be extremely careful while investing your hard earned money in an unregulated chit fund. Let’s understand how a chit fund works. Say 30 of your office colleagues form a group and agree to start a chit fund. They each agree to contribute INR 3,000 for a period of 36 months. This amount is called the installment. The size of the monthly chit fund is INR 90,000 called maturity amount. Each member of the group is eligible to get the entire maturity amount from the first month itself. Who would get this money? Simple…It is decided by a lottery. After a member gets his name selected through a lottery and gets the money, he is not allowed to compete in the next draw.
What happens if any member needs money in a hurry? Simple…he requests for an auction instead of a lottery. This member makes a bid (submits a bid), for the maturity amount of INR 90,000. But he may not be alone. A couple of other members too require money in a hurry. They too make their bids on the maturity amount. The member who quotes the lowest bid, by offering the highest discount, wins the bid. The discount is between 5% to 40% on the maturity amount. The discounts offered by the three members making a bid are 10%, 20% and 40%. The member who offers a discount of 40%, wins the bid and is called the prized member. The prized member gets INR 54,000 (90,000 – 40% of 90,000) from the maturity amount. The prized member has to forego an amount of INR 36,000, which is distributed among the remaining members of the group after paying the foreman’s commission.
The foreman manages the chit fund and gets a commission. If the foreman gets a commission of 4% of the maturity amount, he gets INR 3,600. (4% of INR 90,000). The remaining amount of INR 32,400 is distributed among the 30 members of the group. Each member gets INR 1,080 which is adjusted against the next monthly payment of INR 3,000. Each member needs to pay only INR 1920 for the next month. What happens to the prized member? He continues paying the installments just like any other member. He cannot bid in any future auctions.
This story gives you a clear picture of why you need to be careful, when investing in an unregulated chit fund. Narendra worked as a blacksmith in his village for several years. Like several of his fellow workers, Narendra was illiterate. When Narendra was 50 years old, he decided to invest his money, to enjoy a better quality of life in his retired years. Narendra had a saving of INR 1 Lakh, which his friend advised him to invest in a chit fund. His friend also introduced him to a newly opened local chit fund. Narendra was skeptical at first, but after seeing several of his friends put their hard earned money in this fund, he too jumped in. Narendra was promised a high return by the agents of the chit fund. Narendra was very happy….His retired years were safe. Unfortunately a few months later, the agents of the chit fund disappeared with all of Narendra’s money. Narendra had lost his life savings in an instant.
Think only the illiterate get fooled by unregulated chit funds… Radha a school teacher in a village borrowed INR 50,000 from relatives and invested it in a chit fund. A year later bad times struck. The agents of the chit fund absconded with Radha’s and several other investor’s money. She never saw her money again. Her relatives blamed Radha for this loss and her family life was in a mess. Radha even lost her job and was in desperate times.
What do you learn from Narendra and Radha’s mistake? Investing in an unregulated chit fund is dangerous. The prize winners of the chit fund could run away, after winning the bid. They might not pay any further installments. This puts the chit fund in a lot of danger. Guess who are the first few prize winners? The relatives of the foreman of course. Remember, if a chit fund exempts the prize winners from paying any further installments, your money is in very bad hands. Think you don’t need financial advice. Think again.
Mr. C S Sudheer is the founder and CEO of IndianMoney.com – India’s largest Financial Education Company. He started his career with ICICI Prudential Life Insurance and later on worked with Howden India. After his brief stint in Howden India, he moved on and incorporated Suvision Holdings Pvt Ltd which is the sole promoter of IndianMoney.com. He aims to build a nation that is financially literate with investment savvy citizens.
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