Chit funds - basics

I did a post once -of-p2p.html and keep getting queries about chit funds... so here goes a post which captures the basics of chit funds. (Disclaimer : I claim to be no expert in this and is purely based on my participation in them a few years ago)

A chit fund is a purely Indian invention of accessing money. To that extent I have in the past compared it to peer-to-peer lending. A few people come together, pool a fixed sum of money for a fixed period regularly and every month based on the need, the money is taken by a member. Lets work with an example : Chit A is for 12 months of 1000 each, so the pool available is 12000 (a small technicality, if there are 24 people in the group then 2 chits will be available that month and so on). So all people pay the money to either a designated person or to the chit fund or operator, and then people who require that money bid for it. So if I were to say bid for Rs 1000, then I will get 12000-1000. I now keep paying my 1000 monthly. What happens to the 1000 I paid? - usually a small portion of it goes to the chit fund/operator as charges. The rest are divided amongst the group in either of 2 forms - as a cash payout or as a deduction from the next payment due. Also there is a variation where there is something called a double chit, which is essentially all the bid amount is collected and is available to the group to bid, so that the time period for which you pay the chit is reduced.

What determines the bid amount - multiple factors but most basic is the cost of carry and the demand for money from amongst the group of members. So the bid amounts are usually higher in the initial stages and keep falling, in large chits mostly towards the end bidding does not happen and base bids are fixed. Also most chit have a reserve price and a minimum tick. The demand and supply works differently - if a group consists of mostly businessmen who are looking at short term funding the rates tend to be higher compared to group of housewives - basic concept of benchmark rates and the return that people can get on the money that they took out of the chit. People ask me why shouldnt they just go start a recurring deposit in a bank - both inculcate the same regular saving habit. Simple answer - power of compounding and higher return. Typically if the group you belong to is of people who bid higher then the return on your investment is high and a RD pays you interest in the end, a chit fund is immediate.

But the fundamental laws of finance - risk and return correlation run true here - higher bids mean people are desperate for that cash, which in turn means strained finances (not an issue if it is a temporary cash flow problem) but if it is long term - one runs the risk of default. Also the other problem is of chit fund operators absconding with the money. so the due diligence that you should carry out is check on the operator first and then your group members before you start. Dont bid unless you need the money and have a good use in mind which will pay you more than what you paid them.

The industry is now regulated, so check if the chit is registered and then step into it. Stick to the biggies, there might be safety in numbers. Avoid mom-pop setup unless you trust those guys with your kids.

So you want to start investing.....

go right ahead, you should, after all there have been tomes and tomes written about how inflation eats into your savings and how you should invest in equity blah blah blah. So here is a checklist of what I think you should be doing -

1. Do you have a clue about what your expenses are? - this is because most of us have a good idea of the income - so get a hang of the disposable income - then how much you dispose every month and see what you have left to invest ( * Note - I am not going to talk about a plan that you need to have before you invest in - thats for a different post)
2. Setup an emergency fund - the funds in this should cover anywhere between 3-6 months of your expenses. I suggest you send this money into a fixed deposit or a liquid fund. Ask your bank to setup a overdraft on this money - so that if ever required you draw down immediately while earning interest
3. Get insured - medical and life - this ensures your lifestyle remains the same ( how much insurance to buy - another post - or will link to some good reading)
4. Whatever is left - split the money into 3
   

• Money you surely want in a year or two - send this into debt products - a bank FD, a Fixed maturity plan, a debt fund - depending on what you are comfortable with
  
• Money you dont want for the next 3-5 years - invest in a mutual fund - select base funds which will form the core of your portfolio - start a systematic investment plan on this and forget about using it - review this monthly and a thorough review quarterly/ half yearly
  
• Money you can afford to lose and will not lose sleep if you lost it - take it and invest directly in shares - but come to this step only if all the above are done

Now how to select a fund , a stock etc - I shall post sometime soon..

Buying insurance online - my experience with insurance mall

I am generally not a good person to sell anything to. I have an inherent need to have lots of data and with financial products, due to my training and the time I have spent in the market, I usually ask a lot of questions. Most of the new age 'financial advisors' don't manage to answer me and my interactions with them are restricted to the first transaction only. The list of such transactions reads like the who is who of the financial advisors today

1) sharekhan - they have lost the opportunity to cross sell anything to me, the guy usually calls in the middle of a work day and doesn't follow up
2) HDFC bank - They still do not understand I have a salary account, my forex transactions, a loan account and a large amount of my funds which are in the FD form with them. So if they had a profiling software, I should come up high, but I doubt if they have anything. So when I approached them for investment, what does the dude do? ask me to invest in NFOs of mutual funds and gives me a list of new funds. While i have nothing against investing in new funds, they better fit my investing framework. And the person from HDFC bank just could not measure up.
3) ICICI direct - These guys are slightly better - when the person who interacts with me
understands he does not know what I am asking, he acknowledges the fact and gets back in 30 mins. Keep up the good work guys, most of my investing offline is shifting to these guys.
4) personalfn - these guys were good, but since I travel so much and insist on meeting guys mostly on saturday mornings , I think this guy gave up.

Ok, the reason for this post - My new company does not have a health insurance, so I was looking to buy one. So I land on the insurancemall site. It is supposedly the best site to buy insurance online and has got wide coverage. So off I went. They have a very nice feature to compare premium and some basic features. But since I wanted more information, I tried the live chat, but could not continue. So they followed up with a mail, so back I went. Tried the live chat, and wanted details about some of the policy fine print. So the person on live chat put me onto a customer care executive who called. He had a transcript of the chat till then ( which shows someone has thought a bit about the business process!!) and started out. While he had the basic information, I wanted to know about the fine print. He tells me it was not available and he would get back. Am still waiting.

So will I buy insurance online, no sir , I think I will stick to my friendly insurance agent and buy it through him. But I will use the insurancemall.in site to look up premiums. Now if only my agent can stop being an agent and convert to a broker and offer me choice of companies from whom I can buy insurance, I will appreciate it.

Maybe I should just give him this idea :)

Are Indian Chit funds equivalent of P2P lending?

This post is primarily triggered by this new (?) concept which is taking off in the west - called Peer- to-peer (P2P) lending. While there are a lot of technicalities involved , at a stripped down level, the concept is - there are a group people who want to lend and there are a group of borrowers. P2P is primarily trying to bring these two through low costs media like internet and social network sites like facebook in the US. So why the need to invent a new mode of lending?

When I want to earn some interest on my savings, ( I would invest in equities !!) but for the portion that needs to go into the debt part ( you should should should have a balanced portfolio mind you!!) I keep them in banks. The banks give me x% and then lend it to corporates and other people who need funds at x+ delta %. The additional interest is called by Net interest margin figure ( NIM) in the analyst statements check it out. The spread is supposedly to cover for the various costs - admin, sales, Delinquencies, salaries etc..... but most banks make a lot of money in profits. While as a shareholder , I wouldn't mind, as a customer from both sides , I would like low cost options - enter P2P lending.

I think it will work fairly well in the US and in other countries with well developed credit rating systems. To be eligible for a loan on most P2P lending systems you need to have a minimum credit rating and even then even if you have large outstandings then you do not qualify. The network charges some admin expenses but the net as a medium will lower the costs significantly. Typically the network will also ensure they get a collection agency to collect ( unlike in India, I assume these guys are not goons !!) and report any default to the credit rating agencies.

So the most important component , the credit score is missing in India. CIBIL , the credit bureau has started in India, but a guy like me who has had no bounced cheques, no credit roll over, a fully repaid education loan, partly paid personal loan will still get treated like the same jetsam/flotsam who have multiple defaults.... so P2P is a far call in India still...

But chit funds, where few people get together, pool a sum of money for a fixed period and one of the participants gets the kitty by bidding for it , is quite similar a setup I think. while currently I think chit funds are being regulated by RBI ( need to check!) , I think its a wonderful instrument for people who do not have access to normal banking channels but have a good social network. Also maybe this model needs to checked by our uber cool Micro finance institutions and not try to become proxy banks and increase the costs...