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When must investors opt for SWP?

Last updated on: September 23, 2017 11:34 IST

Don't opt for a SWP when you have a regular cash flow.
During such times, opt for a SIP.
Morningstar answers important questions on SWP.
Illustration: Uttam Ghosh/Rediff.com

On reading How to turn your fund into a retirement paycheck, readers wrote in with queries regarding the SWP.

So here's to gaining a better understanding on the subject.

A systematic withdrawal plan, or SWP, is a facility that allows an investor to withdraw money from an existing mutual fund at predetermined intervals (a fixed date every month, once every two months, or even quarterly).

This generates an additional cash flow without the requirement of liquidating the entire investment.

1. When is the best time to opt for a SWP?

Do not opt for a SWP when you have a regular cash flow.

In fact, during such times, you must opt for a systematic investment plan, or SIP.

This is the time you should be putting your money to work to attain your goal of wealth creation.

Retirement is the best time to opt for a SWP.

It is during this phase that you no longer earn a regular monthly paycheck, which means that the money has to come from somewhere else.

Most investments are designed to provide some form of income.

So your income stream could take the shape of interest payments from your fixed deposits/bonds, dividends from your mutual funds/stocks, an annuity plan, rental income, or a pension from your erstwhile employer.

This is where the SWP from your mutual fund will help you grow your money as well as obtain an outflow.

This has been tackled in detail in How to turn your fund into a retirement paycheck.

2. What withdrawal flexibility does the SWP offer?

There are two options. A SWP can be set up to withdraw only a portion of the capital appreciation.

The good part is that the entire capital stays invested but one can enjoy the gains in the event of an appreciation.

It goes without saying that this works extremely well in a rising market.

The problem takes place in a downturn.

If there is no appreciation at all, there will be no payout.

Or, the payout would be very highly diminished.

What's the alternative? Opt for a fixed amount to be withdrawn.

This will ensure that you do get a cash flow into your account in an up or down market.

But in a down market, naturally your fund units will have fallen in value.

Consequently, more units have to be liquidated to meet your withdrawal needs.

So in a market correction or bear market, this has the reverse effect of a systematic investing plan where your money buys more units.

With that perspective in mind, the way forward is to opt for a SWP from a hybrid fund which has a predominantly equity portfolio but also some amount of debt.

So in a stock market downturn, the fall will not be as steep as that of a pure equity fund.

3. How long will a SWP last?

Tough to say. It depends on how big the kitty is to start with and how much the withdrawal is.

Basically, the higher your withdrawal rate, the faster will be the depletion.

As long as the fund is doing well in a good market, the SWP will keep delivering on that momentum.

Let's illustrate with an example.

Assume you start the SWP in a fund where your investment is Rs 2 lakh.

You own 10,000 units whose current NAV is Rs 20.

Your SWP pattern is to withdraw Rs 5,000 on the first of every month. So 250 units get sold and the money is transferred to your bank account.

You now have 9,750 units and your investment has now dipped to Rs 1.95 lakh.

Over the month, the NAV rises to Rs 21. So your investment is now worth Rs 204,750 (9,750 units x Rs 21).

To give you the monthly Rs 5,000, around 238 units will get sold.

Leaving you with 9,512 units which translates into your investment being worth Rs 199,752 (9,512 units x Rs 21).

Unfortunately, the reality is that markets never move in one direction. They fluctuate. They go through upturns and downturns.

Of course, if there is a significant positive momentum in the first few years of the investment, it should put you on a stronger note.

But the downturns will take their toll.

Kind courtesy

Morningstar