We were recently asked some questions on mutual fund systematic withdrawal plans (SWPs). I thought it best to prepare for the interview by writing an article answering the questions. The essentials of an SWP have already been covered in a previous FAQ. So we will dive right into the questions.
What is your opinion on SWP? Is it worth the hype?
They are not necessary IMO. You can redeem from a mutual fund whenever you want to. Even if you wish to make regular withdrawals, do it from safe debt funds like liquid funds or money market funds in which the NAV is typically stable.
Never use any hybrid fund (except perhaps arbitrage funds if you understand risks and have enough corpus) like multi-asset, aggressive hybrid, balanced advantage etc. Their NAV is too volatile.
Does market volatility impact SWPS?
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Yes! If the NAV keeps falling, you must withdraw more and more (sell back more units to the AMC) to redeem the same amount. Do not trust any SWP backtest as the past sequence of returns will not be repeated.
What are the advantages & pitfalls of using SWP for retirement income?
The biggest danger is a poor sequence of return – a bear market lasing for years – which will quickly deplete your corpus.
Is there any difference between manual SWP & automated SWP offered by AMCS?
Not in terms of risk. If you understand what you are doing and have enough corpus for retirement, you can set up an automated SWP or manually redeem.
How can a DIY investor assess the adequacy of their corpus before initiating SWP?
Divide your annual expenses (minus any pension) by your corpus. If this ratio exceeds 4.5%, you cannot afford to take on market risks. Forget about SWP, you cannot invest in any equity-oriented fund.
If this ratio is less than 3.5%, you can have up to 20-30% equity exposure (but not SWPS from these).
If the ratio is between, then it is a grey area. You can have a small equity exposure, but most assets should be in safe instruments.
How does SWP work compared to other annuities or FDS from a tax-saving perspective?
In a mutual fund, you pay tax only on the amount redeemed. So that could mean lower tax if the amount withdrawn is lower than an annuity or the FD interest. The downside is that the principal is not protected in an MF. Each redemption will deplete the principal. However, tax should never be the top priority when choosing an instrument.