Many people are confused about the safety of savings accounts and whether bank deposits are a good option. While savings accounts are essential for financial security, it is crucial to calculate interest and weigh the benefits and drawbacks.
Investing in a savings account can be profitable. For example, if you invest Rs. 1,300 per month in a savings account with a monthly payment requirement of Rs. 2,000, you will earn a profit of Rs. 700 for that month.
If you invest Rs. 2,000 monthly for 50 months, you could accumulate Rs. 1 lakh. Initial savings in a bank may seem low, but they tend to increase over time, making it a manageable option for many people. Saving in a savings account is often helpful for meeting future needs.
In a bank recurring deposit, you can earn up to 9.5 percent interest and compound interest is applied every three months. If you save Rs. 1,555 monthly in a bank recurring deposit, you could receive Rs. 95,008 after 50 months.
Another option is chit funds, which can confuse the safety of various bank deposits. When you join a chit fund and make regular payments over 50 months, you can leave with interest earnings that may range from 14 to 18 percent. Some argue this interest is higher than the 9.5 percent typically earned from bank deposits.
So, how does a chit-fund work? A chit fund involves several participants who contribute a fixed amount monthly. The accumulated amount is paid to one member who needs money each month.
For instance, if fifty people each deposit Rs. 2,000 per month, one lakh rupees is distributed monthly among them. In cases where multiple participants require funds simultaneously, an auction is held.
If there are no competing requests, the chit fund managers take a 5 percent commission from the total amount, with the remainder going to the member in need.
If multiple members compete for the chit-fund money, an auction takes place to determine the winner, who may be selected by lottery if no apparent bids emerge. Under the Chit Fund Act, a participant cannot withdraw over 40 percent of the amount.
Since a participant who has withdrawn a portion will incur a loss of up to 40 percent of the profit, the remaining members must only contribute Rs. 1,200 for that month.
The chit fund managers will also take a 5 percent commission, requiring all members to contribute an additional Rs. 100. Therefore, paying Rs. 1,300 effectively results in receiving only 35 percent of the profit for that month.
Over time, competition among participants tends to decrease, increasing the amounts due each month, culminating in a final month’s payment of Rs. 2,000.
However, this should not be considered profit. If you pay Rs. 1,300 instead of Rs. 2,000 for a chit, you must also account for the interest over the period required to retrieve the entire amount.
Calculating the interest from monthly chit payments as you would with a bank often yields a return of less than 7 percent.
Therefore, it is wise to evaluate both chit funds and banks to decide the best investment choice. Remember, in emergencies, accessing funds from banks may not be as immediate as withdrawing from chit funds.
Understanding Chit Funds: A Clear Overview
The interest earned on a chit fund remains constant. When joining a chit fund, a fixed amount and an entry fee must be paid in the first month.
A chit fund will not commence until 50 members have joined a 50-month chit. The first person to join the chit must wait at least one month before it starts, and they will receive their payout only in the 51st month.
If the amount deposited upon joining is placed in a bank, it will grow to ₹2,821 over 51 months, assuming a 6.5% interest rate.
Only those who enter the chit in the second month will receive dividends. Leading chit-fund companies do not offer interest rates exceeding 6.5%.
In chit funds, managers must pay 5% of the chit amount every month, resulting in a 60% annual profit from chit funds. This is why banks and financial institutions often prefer chit-funds for greater profitability.
In a 50-month chit fund, if a participant pays regularly for 20 to 30 months and then cannot continue, they will receive a refund of the remaining amount after deducting 5% of the total amount paid. Additionally, the bank will pay interest on the recovered deposit.
Many individuals who join chit funds do not fully understand compound interest calculations, making the dividends appear more profitable than they are.
Most people view chit funds as savings tools that provide loans when necessary, unlike bank recurring deposits, which require consistent monthly savings.
Suppose you are considering using a chit fund from the outset. In that case, it’s important to note that withdrawing the chit amount within the initial months requires one to two months to submit the necessary sureties and complete verification.
By the third month of withdrawal, you could receive only ₹60,000 after a 40% deduction. If you account for the three months of paid installments, your net amount would be ₹55,255. When calculated with bank interest rates, this equals approximately 17.6% interest.
Who Benefits from Chit Funds? Individuals withdrawing money during the chit period may not face any losses, but the situation is not entirely profitable.
After paying the chit regularly for 26 months, you would receive ₹83,000 in the 26th month. Excluding the total contributions made up to that point, you have taken a loan of ₹39,990 and will only pay interest over the remaining 24 months.
Understanding these details can help clarify chit funds’ nature and financial implications.