KSFE Chit Funds: A Cautionary Tale for Investors

A chit fund, also known as a ‘chitty’ or ‘kuri’, is a type of rotating savings and credit fasciation system practiced in India. It is a unique financial product that combines the elements of savings and borrowings. In a chit fund, a group of people come together and agree to contribute a fixed amount of money at regular intervals (monthly). The total amount (pot money) is collected in each interval is given to one of the members, determined by a bidding process or handpicked depending upon the circumstances. The chit fund is usually governed by a person in-charge called foreman. Foreman charges a commission to run this chit, which involves collecting money, conducting bidding process and disbursing the prized money to the person for the entirety of the chit duration.

There are various organisations which run chit-funds some are government/state owned like Kerala State Financial Enterprises (KSFE), Myre Sales International Chits and privately owned such as Margadarsi Chit Fund, Sree Gokulam Chit & Finance, Kapil Chit Funds to name a few and these are governed under Chit Funds Act, 1982 of the respective state in which they operate.

Then there are unregistered chit funds which are run by people due to necessity or for a common goal among friends, family, workers union and is quite popular mode of fund collection in the Middle East among the Indians there. As it helps to pool in money combined and to pay them back in instalments over the course of months is convenient for migrant workers. This entitles for the risk involved as we have heard multiple stories of how big companies have cheated people in the name of chit (Sharada Group in West Bengal, recently Royalfine India Nidhi Limited Bank in Ghaziabad) and how the unregistered chit fund operators have cheated gullible people which has gone unnoticed.

The Kerala State Financial Enterprises (KSFE) is a government-run organization that operates these chit funds and is the foreman in legal terms. KSFE charges a flat 5% commission on all their chit funds as foreman commission. The reason to choose KSFE was simple as it was run by the state government and not a private player it gave a sense of security and choosing KSFE from various government run chit fund was due to their outreach in terms of branches, their intrusive website, ease of operations online and through their app KSFE Power.

My Journey with KSFE.

I joined a KSFE Chit Funds of ₹ 25,000 per month for a duration of 40 months. My aim was to see if I could generate better rates compared to other financial instruments available in our finance system. There were tons of reviews on how these faired but I wanted to experience it for real as all reviews lacked any in-depth knowledge and was intrigued by how chit funds function and how they fare as a safe return bearing than traditional banking or stock markets.

How exactly does the chit function and you might be wondering as it looks straight forward (25000 x 40 = 10,00,000/-), but there in lies the rub. In my case the chit had 40 members and each member is entitled to receive the chit amount at a certain period of time and how does that gets determined is the exclusive feature of Chits. In our case the chit was to be called out for an auction (traditional auction requires the person to bid the highest would receive the winnings) and during these auctions the person who forgo the maximum amount (capped at 30%) of the chit would receive the prized chitty. 

In our scenario the maximum amount a person to forgo call the chit was capped at ₹ 7,00,000. In lay it means the person would get the prized amount after foreman commission of 5% (ie 50,000) would be ₹ 6,50,000 and the person who has successfully bid would get the amount instantly and would have to repay the remaining amount monthly.

This is where we as an investor in the chit funds gets benefit if the person has called for the maximum would get the benefit of  ₹ 6250 which is called as dividend (i.e. 25% of 25,000) and in next instalment we would have to pay only 25000-6250 = ₹ 18750

The initial 6 instalments went for the maximum resulting in good dividends and I was enthralled to see spreadsheet calculations showcasing healthy dividends resulting in superb returns overall, that excitement was short lived as the next 20 instalments were mediocre the dividend amount was diminishing by each passing auction months and after Instalment no.28 nobody really wanted to take part in auction.

Basically, that meant only 28 out of 40 persons wanted Chit money earlier out of which 6 people were really in need of it direly for their needs and rest 22 people were not that keen and wanted only if the others didn’t want them that resulted in less dividend overall and the rest 12 people were pure investors and didn’t pursue auction. Now from 28^th auction onwards it was basically like a roll call and we all had to pay 25000 per month till the end.

Now the real drama and real calculations were coming into picture, I got my prized chit in Instalment no.31. After completion of all the formalities which you can opt to do it via online or by visiting the branch at which your chitty is based. I was in a for a shocker!

The Hidden Costs of KSFE Chit Funds

One of the first things I noticed was the multitude of charges associated with the chit fund all these charges are not mentioned up front as it lifts the charm off the chits as per the manager with whom I had a conversation with. A significant portion of the returns was deducted as the foreman’s commission, which was 5% of the total chit amount. In our case it was 50,000. Additionally, the Goods and Services Tax (GST) applicable 9000 on the foreman commission is 18% (i.e. 18% of 50,000) then comes the document charges of 200 for getting into an agreement with KSFE, next up is postage and stamp charges of 30 rupees these deductions significantly reduced the net profit I received. Luckily 1% cess was removed from 2021 otherwise it would have been a bummer. Grand Total of Deduction ₹ 59230 (5.9% of the Chit Amount) 

The Returns

This part pains me a lot, with an investment horizon of 3 years and 4 months. I received a total of ₹ 9,40,770 (Chit Amount – 10,00,000 minus Deductions – 59230) against an investment of ₹ 9,19,408 (amount invested over the 40 months). After 40 months of regular contributions, the net profit I received was ₹ 21,362 mere absolute return of 2.32% and XIRR of 2.62%. When compared to other investment options available, KSFE Chit Funds returns was rather daunting and disappointingly low.

Comparing KSFE Chit Funds with Other Investment Options

 Savings Account

A savings account is one of the most basic and risk-free investment options. The interest rates for savings accounts in India range from 2.50% to 7.15%. If we do the math with the same investment amount, time horizon, the savings bank with 3% interest rate would fetch about ₹ 52,218 which is significantly higher. However, the interest earned on savings accounts is taxable, which slightly reduces the net return. 

Recurring Deposit

A recurring deposit (RD) is another low-risk investment option where a fixed amount is deposited at regular intervals. The interest rates on RDs in India range from 2.50% to 7.50%. The interest on RDs compounds quarterly, which can lead to higher returns over time. However, the interest earned is taxable and premature withdrawals may attract penalties. With these stats even RD with 5.5% returns will fetch you approximately ₹ 99,300 over the course of 40 months.

Mutual Fund SIP

Systematic Investment Plans (SIPs) in mutual funds have become a popular investment choice due to their potential for high returns and the flexibility they offer. The returns from SIPs in mutual funds can vary greatly depending on the fund and market conditions. The equity mutual funds have offered more than 30% SIP returns in five years.
However, mutual funds come with their own set of risks and the returns are not guaranteed. Suppose, if we invest the SIP amount of ₹ 25000 per month in a safe and performing Index Mutual Fund (Nifty 50/Nifty100) with an expected return of 12%. It will fetch ₹ 2,20,000 approx. during the 40 months period.

Equity SIP

Equity SIPs are similar to mutual fund SIPs, but the investment is made directly in equities. The returns from equity SIPs can be quite high, with these equities fetching over 50% returns. However, like mutual funds, equity SIPs all come with a high level of risk and the returns are subject to market fluctuations. There is no assurance that the stock you have picked will perform due to volatility and unlike the mutual funds which are managed by fund managers. Suppose, we had invested the same amount of 25,000 in an SIP form with ITC for the same duration timeline. It would have fetched ₹ 4,75,722 approx. with a return rate of 24.44%.

Analysis

Is KSFE Chit Funds a bad investment wagon?

In our analysis, KSFE Chit Funds did not perform in any of the investment parameters pitched against the traditionally available banking products and even LIC fared well against. There are various assumptions to consider before concluding. KSFE could have been a better product if more people would have taken up the chits at the regular intervals, still it would have not bettered RD, Mutual Funds or Equity.

There are other products from the KSFE, what we analyzed is of the regular chit. They also have a another chit product called as multi-division chit fund, where in there is a possibility of getting the chit earlier by lucky draw (chances 1 out of 4) and without compromising the dividends. If you like this piece of work from us, we would also review this product for you!

KSFE also operate as NBFC, offering various products such as Savings account – Sugama @ 4.5% per annum which is higher rate of interest than most of the traditional banks (State Bank of India – 2.7% per annum) albeit without the convenience of Debit Cards. Fixed Deposit account at 6.7% per annum returns and various other products such as Short Term Deposit Schemes, Gold Loans & Safety Locker facility.

Question of the hour is then what are the benefits of KSFE Chit Funds ? And who needs it?

All this while we were considering KSFE Chit Funds as an investment tool, rather if we had analyzed it as an alternative to loans given by the financial institutions it probably would have fared, as the parameters set by the Banks are different to how it is perceived by the chit operators.

It serves well for people who bid in early and take the maximum amount possible by way of auction, though the maximum amount lost will be 30% (3,00,000), the minimum amount received will be effectively ₹ 6,50,000 (7,00,000 – 50,000 – 5% foreman commission) and maximum will be 9,50,000 out of 10,00,000. In this scenario, considering a person received the 1^st Chit for minimum auction amount of ₹ 7,00,000. This person would have paid back ₹ 9,19,408 that would have resulted in an interest rate of 16% per annum.

Exactly! this could be easily treated as a personal loan, usually the personal loan granted by the financial institutions. The interest rates varies wildly ranging from 9% if the CIBIL score is good and has a good reputation to 55% if the person is right at the bottom strata of eligibility. In this aspect KSFE fairs and is easily given without the complicated paper works of the financial institutions and loan processing charges but certainly there is a catch, the successful bidder must show how he/she will repay the prized amount, some sort of guarantees are required such as surety of a credible person or of a Government Employee, Unprized Chit Holder equal or greater than the value of the chit disbursed, Gold, Silver, FD, Documents of Immovable Properties.

The question lies what makes it different from the Financial Institution loans, the paperwork is quite straight forward and does not involve scrutiny at the level of CIBIL, the processing charges are not applicable, no need to take compulsory insurances. It helps small time business owners majorly and for people who are in need of money for any emergencies. This is the reason why KSFE is quite popular in the state of Kerala as the agony of visiting a bank and following the process is quite cumbersome and is avoided by people who are not in the purview of Income Tax.

Conclusion

KSFE Chit Funds may not be a great financial investment option available nor it is a good financial saver, if these are your main aspirations the answer lies elsewhere. While KSFE can be a convenient savings mechanism for some, especially those without access to formal banking facilities. It can inculcate the habit of savings for a person who has not started it yet and are not in a stratum to go through the hassle of opening one with the traditional bank setup. Chit Funds may not be the best choice for those looking for high returns and low risk. It is always a good idea to diversify your investments and explore other avenues that can potentially offer better returns.

KSFE can be considered as a friendly neighbour who happens to run a chit business and is willing to finance your small needs. A home maker who wants to change their furniture at home without burdening their pockets or a shopkeeper who wants to stock up for the upcoming festive season or an NRI building a house in need of money to complete the dream home. A quick resolution available next door. What I have seen is most of the people who are into blue collar jobs take up a chit and go about their lives normally, if a situation arises, they have something to lean on or they have a saving at the end of the tenure.

In summary, KSFE chit funds may not be a grand investment strategy, but they serve a purpose—a neighbourly one. So, the next time you need a quick financial resolution, consider knocking on KSFE’s door—it’s right next to yours!

Remember, every investment decision should be made after careful consideration of your financial goals, risk tolerance, and investment horizon. Always do your research or consult with a financial advisor before making any investment decisions. I hope this article provides valuable insights for those considering investing in chit funds. Always remember, informed investing is smart investing.