In this article, we cover the essentials of a mutual fund systematic withdrawal plan (SWP) by answering some frequently asked questions.
1: What is a Systematic Withdrawal Plan?
The SWP is the opposite of a SIP. In a SIP, you invest a fixed amount each month (the most frequently used interval) and build up a lump sum. In an SWP, you invest a lump sum and withdraw a fixed amount each month (typically) to be used as a source of income.
The withdrawal is done in such a way that the product of units redeemed times the current NAV is equal to the fixed amount desired.
2: Why were SWPs created?
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Anything that the AMCs do is for their benefit primarily. With an SWP, the AMC (and their salesmen) earn a fee/commission on the lump sum invested and this income reduces gradually with each SWP instalment. Unlike a SIP where the fee/commission builds up gradually over time, the SWP provides instant profit and is more beneficial to the AMC considering the time value of money.
3: When should I use an SWP?
Just like a SIP, an SWP is entirely unnecessary (the same goes for the STP too!). If you want to invest in a mutual fund each month, do so manually on any day of the month convenient to you.
If you want to withdraw from a mutual fund, do so whenever you like! There are no extra benefits of a SIP or an STP. Not getting tied down to a SIP allows you to invest as much as possible each month and vary the investment amount at will depending on your needs.
Similarly, not using an SWP allows you to redeem what you want and when you want.
4: Which type of funds can be used for SWP?
The SWP amount for any month = Current NAV x no of units.
If the NAV on the date of redemption is low, then more units will be redeemed and the investment will deplete faster. If the downward trend continues the entire corpus will get exhausted much sooner than anticipated.
Therefore the simple thumb rule is, never set up an SWP from a fund in which the NAV is volatile (eg. equity funds, so-called balanced advantage funds, aggressive hybrid funds etc are to be avoided). These types of funds offer higher incentives to the sales guy!
We recommend using only funds like liquid funds, overnight funds, money market funds for regular withdrawals.
Those with a higher risk appetite (meaning more cash to burn) may consider ultra short term funds, arbitrage funds. Conservative hybrid funds or other long-term debt funds may be used by those with an even higher risk appetite.
5: What precautions are necessary before setting up an SWP?
The SWP is incorrectly recommended as a way to get a regular income after retirement from volatile mutual funds as mentioned above. Senior citizens with limited capital market experience in their youth and/or limited funds to work with should not be enticed with the advertised claims of “income with growth”.
Trying to maximise retirement income with less than an ideal corpus is an extremely difficult problem in finance and an SWP from a volatile mutual fund can result in irredeemable disaster.
Beware of SWP backtests with balanced advantage or any other mutual fund. The past performance does not reflect future performance disclaimer applies!
6: Can I use an SWP as part of a retirement bucket strategy?
Yes, but as mentioned above it will have to be from something like a liquid fund for either the main income (in case of no other pension source) or for handling discretionary expenses. See for example: I am 30 and wish to retire by 50 how should I plan my investments?