What are Chit Funds?

Chit Funds are a type of rotating saving scheme and credit association that has existed in India for a long time. Every month a group of individuals come together and contribute a fixed amount of money. Each member can receive the entire sum once during the tenure of the chit through bidding or an auction system.

Let us consider a chit fund with 10 members and everyone contributing Rs 1000, creating a monthly pool of Rs 10,000. Every month, members bid for the pool, and the one bidding the lowest, say, Rs 7000, wins. The remaining amount of Rs 3000 is distributed equally among the rest as a dividend. This cycle continues until every member has received the pooled amount once.

 

What are Mutual Funds?

Mutual funds are a type of investment vehicle that pools money from multiple investors to invest in a diversified portfolio of assets according to the fund objective. These funds are professionally managed by fund managers who invest on behalf of the investors and generate returns.

 

Chit Fund vs Mutual Fund

Here are the key differences between chit fund vs mutual funds you must know before investing:

Parameters	Chit Fund	Mutual Fund
Structure	Group of individuals contribute fixed amounts regularly into a pool	Fund managers collect money from multiple investors to invest in a diversified securities portfolio
Objective	Savings and borrowing mechanism	Long-term wealth accumulation and appreciation
Management	Chit fund companies or organizers	Fund managers
Returns	Depends on the bidding process	Linked to the portfolio performance
Risk	Reliability and integrity of the organizer	Market risks
Liquidity	Early withdrawal not possible	Highly liquid as investors can redeem their units as per Net Asset Value (NAV) on any business day
Diversification	Limited	Possible
Regulatory	Registrar of Chit, Oversight	SEBI
Duration	Fixed duration	No fixed duration
Size	Contributions can be flexible	Start with small amounts
Accessibility	Individuals with limited access to banking services	Banks, financial institutions, and online platform

 

Tax Efficiency of Chit Fund vs Mutual Fund

As with the differences, the tax benefits associated with the chit fund and mutual fund are unique to them. Here is an overview of the tax efficiency of chit funds and mutual funds:

 

Chit Fund

Interest earned on Chit Funds is taxed as "Income from Other Sources." The rate of tax depends on the individual's income tax bracket. There are also no special tax breaks for Chit Funds. When a member withdraws their portion of the Chit Fund, no additional tax is levied.

 

Mutual Fund

Long-term capital gains (LTCG) from equities mutual funds are taxed at 10% if they reach ₹1 lakh in a year without indexation. For debt mutual funds, short-term capital gains (STCG) are taxed at the individual's income tax bracket rate, whilst long-term capital gains (LTCG) are taxed at 20% with indexation benefits.

 

Conclusion

Both mutual funds and chit funds can serve as essential investment tools for investors. Mutual funds aim towards wealth accumulation, whereas chit funds prove to be easy borrowing means to get hassle-free loans. Chit Funds are simpler in terms of taxation, but they do not provide any unique tax benefits. However, mutual funds provide greater tax-saving opportunities.