A systematic withdrawal plan or an SWP enables you to systematically withdraw a fixed amount from a mutual fund scheme that you have invested in, at regular intervals (such as, monthly or quarterly).
While SWPs can come handy if you need regular cash flows, here are a few things to know before you opt for one.
When you go for an SWP, the cash inflow that you receive comes from redemption of your scheme units at periodic intervals by the fund house. So, with each passing month, the number of MF units held by you will go on reducing. For example, you invest Rs. 5 lakh in an MF scheme. If at the time of investment, the scheme NAV is Rs.20, you get allotted 25,000 units. Suppose, you start a monthly SWP of Rs. 5,000 a year later. Let’s assume the NAV is Rs. 25 at the time of the first SWP. To generate the SWP amount, 200 units will have to be redeemed and the number of units held by you will reduce to 24,800. At the end of next month, if the NAV is Rs.28, then approximately 179 units will have to be sold for the SWP. At the end of this, the number of units will go down to 24,621 and so on.
If during this period, the scheme NAV has been appreciating, then even though you will be left with fewer units, your final investment value may still be higher than what you started with. That means, the returns generated by the scheme will have funded your SWP. But, if the NAV has been depreciating or if you have been withdrawing at a rate faster than at which the NAV has been rising, then the SWP will have been funded from your original investment itself.
Wait it out
One way to deal with this is to possibly wait for a few years before you start an SWP. This can allow your original investment some time to grow before you begin withdrawing from it. This can also be more tax efficient. When scheme units are redeemed for the SWP, capital gains, if any, on them are taxed. Capital gains on sale of equity fund units held for more than 12 months and debt fund units held for more than 3 years are taxed at a lower rate than when they are sold within 12 months and 3 years respectively.
Equity vs. debt funds
Note that, every time the SWP comes due, the higher the scheme NAV at that time, the fewer the number of units that must be sold and vice versa.
During periods when the equity markets are on a rise and valuations are high, an SWP can be a good way to book some profits. Also, fewer units will have to be redeemed for the SWP in such times. On the other, in a bear market, the cash flow for an SWP will have to be funded by selling a far larger number of units, not ideal from a long-term return perspective. Not only that, this may actually be a good time to buy more units and lower your average purchase cost rather than have units be sold off for funding the SWP.
Going for an SWP from a debt fund may, therefore, be a better option. While returns from debt funds may not match those from equity funds, they are likely to be less volatile. You can consider, say, high credit quality low duration or ultra-short duration funds which derive their returns largely through interest accruals and are relatively less exposed to interest rate risk.