Mutual Funds

SWPs, in black and white

Maulik Madhu BL Research Bureau | Updated on September 04, 2021

Unlike the interest from a bank FD, there is no ‘guaranteed fixed return’ in the case of systematic withdrawal plans

Systematic withdrawal plans or SWPs have often been marketed as a source of guaranteed monthly income — like the interest income from a bank FD — to mutual fund investors. As the name suggests, an SWP enables you to systematically withdraw a fixed amount at regular intervals (say, monthly or quarterly) from your MF scheme investments. However, unlike the interest from a bank FD, there is no ‘guaranteed fixed return’ here. Here are a few points to note before going for one.

Erosion of original investment

When you opt for an SWP, you receive cash flows that are generated by redeeming your scheme units at periodic intervals. Say, you invest ₹5 lakh in a scheme. At a purchase NAV of ₹20, you are allotted 25,000 units. You start a monthly SWP of ₹10,000, say, a year from then. Assume, an NAV of ₹25 at the end of the first month. To generate the SWP amount, 400 units will have to be redeemed, after which the total number of units will fall to 24,600. At the next month-end, if the NAV is ₹27, then 370 units (approximately) will have to be sold, further bringing down the number of units to 24,230 and so on. With each successive month, the number of units held will go on reducing.

If during this time, the scheme NAV is appreciating, then despite holding fewer units, your final investment value may be higher than the initial one. That is, the SWP will have been funded from the scheme returns. On the other hand, if the NAV is depreciating (or if the rate of withdrawal is higher than the rate of rise in the NAV), then the SWP cash flow will be met from scooping into your original investment.

Using the NAV data for one of the prominent flexi cap funds, we check what an initial lump sum investment of ₹5 lakh in end of December 2009 grows to by December-end 2014. In case of no SWP, the ₹5 lakh becomes ₹10.4 lakh by December 2014. In case of quarterly SWPs of ₹20,000 starting from say, March-end 2011, the final investment value turns out to be ₹4.97 lakh. By then, SWPs totaling ₹3.2 lakh too have been made. The point to note here is that in the initial part of the time period taken, the fund NAV was falling. Only later on, does the NAV start rising. By then, large withdrawals have been made under the SWP option thereby leaving a smaller corpus for further growth once the NAV starts rising. Had the NAV trend been the reverse (first a rise and then a fall), the gap between two final investment values (with and without SWPs) would have been smaller.

So, a regular payout via an SWP may be accompanied by a decline in the value of your original MF investment. But a fixed deposit, while paying monthly interest income, also keeps your principal intact. The two are, therefore, not comparable.

One way to get around the problem of an SWP eating away into your capital is to opt for an appreciation withdrawal SWP where only the appreciation gains are withdrawn. However, this may not ensure a steady cash flow from month to month. More importantly, waiting a few years before starting an SWP from an MF scheme can give your initial investment some time to grow before the withdrawals begin. This can also be more tax efficient. When scheme units are redeemed for the SWP, capital gains, if any, are subject to taxation. Capital gains on sale of equity fund units held for more than 12 months and debt fund units held for more than three years attract lower taxation than when sold within 12 months and three years respectively.

Selling, instead of buying

That said, unless you require a regular income inflow, it’s best not to go for an SWP. Higher the scheme NAV, fewer the number of units that must be redeemed for an SWP and vice versa.

In case of an equity fund, in periods when markets are on a rise and valuation are soaring such as today, an SWP can be a good way to take some profits off the table although the number of units that need to be sold may not be that high. On the other hand, in bear market periods, the cash flow for an SWP will have to come by way of sale of a significantly larger number of units, which can be counterproductive. Such a period may in fact be a good time to buy more units (and lower your average purchase cost) than redeem them.

Going for an SWP from a debt fund may, therefore, be a better option. While long-term returns from debt funds may fall behind those from equity funds, they are likely to be steadier from year to year. One can consider going for high credit quality debt funds from categories such as low duration, money market and ultra-short duration funds. These funds derive their returns largely through interest accruals and are relatively immune to interest rate risk, ensuring lower return volatility.

Published on September 04, 2021

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