The person I first learned about ‘committees’ (pronounced ka-may-tee) from was my dadi. She wanted to buy a washing machine for the house, and so she called up my father’s aunts and asked them all to join a committee. Back then (this is the mid-1990s), the washing machine cost Rs2,000 and so she got 10 people to join a committee to each contribute Rs200 every month for the next 10 months. Since she initiated the committee, she got the cash first and was able to buy the washing machine almost immediately.
That, in a nutshell, is how most committees work: a group of people get together to pool a specific amount of money and every month the entire pot of money goes to one person.
First, let us start off with what is good about the committee system. It uses social trust and ties between family and friends as a means of getting a group of people to collectively force themselves to save money, and thus have access to a lump sum for large payments or purchases that might exceed their monthly incomes.
That, however, is the beginning and end of the advantages of the committee system. There are three reasons why it is bad, inefficient, and why the committee system – especially the single round committee, where all of the people go around only once rather than having a running committee – is actually unfair.
In this article, we lay out exactly how the shortcomings of the system. We will then lay out how people can overcome them to continue benefiting from the forced savings mechanism.
- It does not protect one’s savings against the impact of inflation [restrict paid=”true”]
Intuitively, everyone understands this, but it is still helpful to lay out. Built into the structure the committee system is a major flaw: it does not involve any actual investing and keeps every person’s money as cash. That means that the money is not protected against the steady decline in the purchasing power of the rupee, which means that the value of the money you are saving keeps declining over time.
Let us use a concrete example. Suppose a group of 12 friends decides to do a committee together and they each put in Rs10,000 every month into the committee so that every month, one member of the group gets Rs120,000 to spend or save as they please.
The problem, however, arises with the fact that the rupee’s purchasing power declines over the course of those 12 months. The long term average inflation rate in Pakistan is about 8% per year, which means that if you want the Rs10,000 you saved in the first month to retain its purchasing power by the twelfth month, you need the Rs10,000 to be worth Rs10,731 (we applied 11 months of inflation at 8% a year; this involves using exponents and logarithms, not division and multiplication alone).
But of course, that money will not be worth that much because it was not invested in anything at all. It was kept in cash the whole time. Even worse than that, it was not kept with the saver at all: it was given to someone else. This leads us to the second – and biggest – problem with committees: they are biased in favour of people who get the money earlier at the expense of people who get the money later.
- It is unfair to those who get the cash later
This, in our view, is the single biggest problem with the committee system. In theory, every person gets the same amount of money during the period which the committee runs, whether it be a single round committee or a multiple round committee. In practice, however, the person who gets the money first is basically getting the highest amount, and the person who gets the money last is getting the lowest amount of money, when measured by purchasing power.
Let us return to the example we gave above. In that case, the person who got the money in the first month will get the full Rs120,000 worth of spending power. But the person getting the money 12 months from now will see the purchasing power of that money erode by inflation, without any compensation for that erosion of purchasing power. Nominally, they will get the same Rs120,000 but 11 months from now, when they get the money, that money will only be able to buy approximately Rs111,826 worth of goods and services (again, applying an 8% inflation rate over 11 months).
In rupee terms, that is a loss of Rs8,174 over the course of one year. In this particular example, that means that the person getting the money last is effectively losing almost a full month’s savings to the people who get the money before them.
Of course, while people may not run the numbers, everyone intuitively knows this. That is why one of my father’s aunts said to my dadi: “Why do you always get to go first? We lose money when we go into a committee with you!”
So why do people still do it? Because they do not know of any better way of being disciplined about saving money. But, as we will point out later in this article, there are many better ways that now exist that did not when my dadi first started doing committees.
- It gives people a false sense of comfort that they are saving money
This is the slightly less obvious, but nonetheless important, impact of committees: it gives people the notion that they are saving money, when in reality, because of the impact of inflation, it is just a pre-paid credit card with an interest rate that varies depending on which order you get the money in. It is probably slightly better than an actual credit card – the effective interest rate is usually lower, for instance – but not by much.
When people are putting money away every month, they feel like they are being financially responsible, and building up their savings. Of course, committees mostly end up financing short-term consumption needs rather than long-term savings, so most people – if you pushed them – would agree that it does not really constitute savings, but the psychological impact nonetheless makes them feel like they cannot save much more.
This, then, leads people to save less than they should, which means that they build wealth at a much slower pace than they need to in order to achieve financial security. Needless to say, that is damaging to their financial health.
Good financial management is as much about one’s own psychology as it is about financial mathematics and investing techniques. Knowing your own brain – and not letting it trick you into doing stupid things – is the biggest battle in the war to build wealth for oneself.
So, what is better?
First, let us state the obvious: our parents and grandparents were not stupid when they started using committees. They were responding to a time and place where the financial system did not give them the tools they needed to force themselves to save, so they created one on their own. It is an act of ingenuity that deserves to be applauded for creating a solution for what appeared to be an intractable problem.
That said, we would be stupid to continue acting as though we exist in the same time – with the same limitations – as our parents and grandparents. Things have changed, and the financial system offers a lot more products and a lot more ways to force ourselves to save than ever before.
Before we state what the solution should be, let us first lay out the principles that should guide you in determining the right set of financial services and savings strategies for your needs.
Firstly, always remember to distinguish between short-term and long-term cash needs. If you replace a committee with a financial product, remember that you are looking for something that is suitable for short-term savings needs and so do not invest in things that are more suitable for the long term. So, no stocks or equity-based investments. Conversely, also remember that replacing a committee does not replace the need to invest other amounts of money for long-term needs, such as retirement, buying a home, or one’s children’s needs.
Secondly, remember not just to invest in the right instrument, but to create a mechanism that allows your money to be withdrawn from your bank account automatically and without you ever having to even look at it at all. This last bit is important: no matter how convenient the method of investing (online bank app transfers, for instance), if you have to do it every month yourself, you will not be disciplined and will inevitably skip some months.
In committees, people do not skip months because they have to meet the people they are in a committee with and the social pressure is very strong. If you are replacing a committee with a fixed income or money market mutual fund (our recommendation), your method of investment cannot involve manually making a transfer every month. It has to be an automatic withdrawal from your account every month.
Lastly, remember to save the right amount for your short-term needs. You only make so much money each month, so it is important to get the allocation right between short-term and long-term needs. Invest too much for your short-term needs, and you will struggle to save for your long-term needs, and vice versa. The right balance is important.
Our recommendation is that short-term needs – which we consider synonymous with cash reserves – should equal about three months’ salary, and if you do not have any cash reserves right now, you should plan to save that amount over the course of three years to keep the required monthly saving sustainable. That means that approximately 8.3% of your monthly income (one-twelfth) should go into short-term savings.
Of course, that is just a benchmark, and depending on your situation, you may be able to do more or less in terms of monthly savings. But remember to do your calculations keeping in mind all of your financial goals, and the entire amount you need to save for, not just one or two goals.
As stated above, we recommend using a fixed income mutual fund to save for such needs and setting up automated deposits using standing instructions to your bank to make deposits every month. There are several options available, including Islamic options, though Islamic options almost always have lower rates of return than conventional options.
In an article such as this, we cannot recommend a specific fund, since each individual may have different needs, and different funds may meet those specific needs. We can, however, tell you that some banks allow you to set up automated deposits to mutual funds, and that the HBL app, in particular, is quite good at setting up recurring monthly payments.
In the meantime, try to wind down any committees you are currently a part of, and encourage everyone in your groups to collectively start using better ways of saving money. [/restrict]
(Disclosure: The author is a founder of Elphinstone, a fintech startup that is working to create a free tool called SmartRupee that will allow users to set up automatic deposits into curated, diversified investment portfolios, based on their financial goals.)
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