Eight must-knows about systematic withdrawal plan

The systematic withdrawal plan can work for you. But only if you know how to use it to your benefit. 

Illustration: Uttam Ghosh/Rediff.com

Morningstar explains eight important things for SWP investors

1. A systematic withdrawal plan, or SWP, is an option offered by a mutual fund when you want a cash flow from your investments.

The money is automatically deducted or systematically withdrawn on a regular basis (fortnightly, monthly, quarterly).

At the set, predetermined date, units from your fund are sold and the money is sent to your bank account.

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

Instead, 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.

3. A SWP is an excellent strategy to have when you are looking for some sort of regularity in cash flows.

It could either be that you have moved from a full-time job to a freelance role or have retired from the workforce.

4. 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.

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.

5. If you are very dependent on these cash flow, opt for a fixed amount to be withdrawn.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.

6. Don't confuse the SWP with a MIP.

The Monthly Income Plan, or MIP, is a structured product. It is a debt-oriented hybrid fund with marginal exposure to equity.

Each fund has its own mandate which sets the equity limit anywhere from 10 per cent to 25 per cent, maybe even 30 per cent in a few select cases.

Dividends are given to the investor depending on the fund's ability to generate returns. No guarantees or assurances here.

The SWP is NOT a product. It is merely a facility that allows for disciplined withdrawals from a mutual fund -- it could be any fund; equity, debt or hybrid.

7. Don't confuse the SWP with a STP.

The Systematic Transfer Plan, or STP, allows you to transfer money from one fund to another in a periodic and disciplined fashion.

For example, if you wish to invest in the stock market via an equity fund, but want to do it systematically and not at one go, then the STP comes in handy.

You can park the bulk amount in a debt fund and decide on the fixed amount that can be systematically transferred to the equity fund every month.

The money will earn you more in a debt fund than a savings account. However, this works best if the amount parked is a substantial amount.

8. In case you think the SWP is a magical option which will hold you in good stead always, note these five points.

First, if the amount in the fund to start with is huge, that would help.

Second, higher the withdrawal rate, the faster will be the depletion.

Third, as long as the fund is thriving in a bull 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 2,04,750 (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 1,99,752 (9,512 units x Rs 21).

Fourth, a downturn will take its toll.

Fifth, if you start off with a huge amount and there is significant positive momentum in the first few years of the investment, it should put you on a stronger note.

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