SWP magic: How to use Systematic Withdrawal Plan to maximise gain from your mutual fund portfolio

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The SIP discipline has become a habit for small investors now. It has found acceptance as a convenient tool for drip-feeding sums on auto pilot, in line with one’s cash flow. Yet, the reality is that an SIP is no magic pill for successful outcomes. The point of exit for an SIP is still crucial to the entire return experience. It doesn’t matter how long your SIP has run or in which market conditions you initiated it. If the market misbehaves in the run-up towards your goal maturity, it may sink a chunk of your accumulated corpus.Let’ say an investor initiated a Rs.10,000 monthly SIP in January 2008. The Rs.14.5 lakh invested would have amassed a tidy sum of Rs.28.1 lakh by January 2020—a healthy return of 10.5%. If this sum had been targeted towards a Rs.30 lakh down payment for a new house by March 2020, the investor would have had his goal within sight. But then Covid hit and sent the markets reeling. By 23 March 2020, the SIP would have shrunk in value to Rs.17.6 lakh. A multi-year SIP shredded within a matter of a few weeks. An unexpected turn of events in the last leg of the SIP journey upended the investor’s calculations.So, how do you make sure your money pot survives this tricky climax? It requires another shift in approach. Having adopted the SIP habit for the accumulation phase, the next big shift investors need to make is to harness the systematic withdrawal plan (SWP) for the withdrawal phase. An SWP is a tool that allows one to regularly withdraw a predetermined amount of money from their mutual fund investments over a specific period. It is the other side of the investment equation—the reverse of an SIP—that facilitates a phased exit from investments. Let’s consider the multiple benefits of pursuing an SWP.

SWP prevents impulsive exit
When the target outlay looms closer, it is natural for savers to get jittery. If the market exhibits heightened volatility near the goal date, many exit in panic. This may protect the accumulated pot, but ultimately leaves it well short of the desired corpus. An SWP can provide investors a better means to fight their emotions. It essentially allows a calibrated exit, unlike a one-time lump-sum withdrawal. You end up withdrawing only a smaller portion of your holdings at the lower NAV, for the duration of the market decline. The rest of your corpus remains invested, allowing it the chance to regain value when the market rebounds. The investor avoids timing the entire withdrawal at an inappropriate time, in the same manner that an SIP or an STP does when accumulating money. Arun Kumar, Head, Research, FundsIndia, observes, “Taking out money entirely in the event of a market correction can be problematic. Most market declines and recoveries occur over a span of 12-24 months, which can be absorbed with the help of an SWP.” Besides, the SWP allows one to regularly pocket the gains from one’s investment. This gives the investor further emotional strength to ride out the turbulent phases, knowing that some gains are already in the bank.

Offers certainty and flexibility in cash flow
An SWP is primarily designed to provide a regular flow of income to meet expenses. In an SWP, a fixed amount can be withdrawn— by redeeming equivalent units— every month or every quarter, as may be required. The amount that is withdrawn at every interval does not fluctuate with the gyrations of the market. The quantum of payout remains steady until the corpus gets depleted. This makes SWP a superior alternative to dividend plans (now referred to as Income Distribution-cum-Capital Withdrawal) of mutual funds. In the latter, the dividend payout depends on the profits generated by the fund. The payouts can be erratic, which may prove inconvenient for those seeking a fixed cash flow. It is superior to pension plans offered by insurers, where the amount of pension is determined by the insurer, not the subscriber. With an SWP, you can fix your own pension. Pankaj Shrestha, Head, Investment Services, Prabhudas Lilladher Wealth, insists, “SWP is an ideal tool for retirees to streamline their cash flows in their golden years. Others can also use SWPs to generate a regular, secondary income.”

Timing the exit is crucial to making the most from SIPs

Waiting till the goal due date to exit the investment leaves it vulnerable to market vagaries.

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Further, an SWP lends itself to greater control and flexibility. It allows you to tinker with the quantum and frequency of withdrawals. Several AMCs offer a top-up facility to hike the withdrawal amount to keep pace with inflation. You can even reduce the amount as per your cash-flow needs. This is not possible in dividend plans or pension plans. Even fixed deposits do not offer this flexibility. “An SWP is more flexible as it allows you to change the monthly withdrawal to suit your requirements; you can go higher or lower, if needed. It’s also easier to tap into it to withdraw a higher amount to meet any sudden large expense,” observes Vidya Bala, Head, Research, Primeinvestor.in.

SWP offers several benefits over other options
Apart from tax efficiency, SWP provides flexibility, predictability in cash flows, and liquidity.

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Tax-efficient approach
Whenever you redeem money via an SWP, you pay tax only on the capital gain accrued on the amount withdrawn. The entire withdrawal amount is not taxed. Suppose you hold 1,000 units in fund A, invested at an NAV of Rs.100. Now, say, in the first month, you withdraw Rs.5,000, when the prevailing NAV was Rs.102. So, you redeem 49.02 units, the purchase cost of which is Rs.4,902. You pay tax only on the gain of Rs.98. Further, in case of an SWP from an equity-oriented fund, gains up to Rs.1 lakh in a financial year are tax-exempt. This further reduces the tax outlay. In a fixed deposit, the entire interest income received is taxable. So, if you gained Rs.5,000 as interest from the FD, you would be taxed Rs.1,560 if you were in the 30% tax bracket. In the IDCW plan (dividend option) of mutual funds as well as pension plans, the entire payout gets taxed at the marginal rate. Effectively, the tax paid on an SWP is a fraction of that paid on income from fixed deposits, MF dividend plans and pension plans, making it far more tax-efficient. Shrestha asserts, “After the tax change, the dividend plan in mutual funds has become inferior to the SWP option.”

Tax-efficiency: SWP versus IDCW
While the entire dividend payout in IDCW gets taxed at marginal rate, the effective tax on SWP is much lower.

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Note: Assuming you invest Rs.1 crore in an equity-oriented scheme at 12% return and 8% SWP. Gains from capital calculated on redemption of units, factoring in rs.1 lakh exemption from the second year onwards.
Source: Edelweiss MF

When to initiate an SWP
While setting up an SWP for income after retirement, the starting point is straightforward. If, however, the intent is to chart a smoother exit path while approaching a financial goal, timing the SWP appropriately is critical. First, it is advisable not to initiate the SWP immediately after the initial investment. Defer setting up the SWP until the in vestment has run for a few years. This will allow your original investment some time to grow before you begin withdrawing from it. Accumulating higher gains on the investment will make sure the SWP does not chip away at the initial capital quicker. “Starting an SWP too early can be counterproductive. If the market starts falling immediately, the SWP will start eating into the capital very quickly. To get the maximum benefit of compounding, let the investment run for a few years before initiating an SWP,” remarks Niranjan Avasthi, Head, Product, Marketing and Digital, Edelweiss AMC. Besides, deferring the SWP will turn out more tax-efficient as any exit will qualify as long-term investment, fetching tax exemptions. Capital gains on sale of equity fund units held for more than 12 months are exempt up to Rs.1 lakh per financial year and the excess gains are taxed at a lower rate.

How close to the goal date should one begin the graded exit? Experts suggest that investors should check the progress towards the target goal a few years in advance. For non-negotiable goals, leaving this review until the last year may put the goal at risk. According to PrimeInvestor, past data suggests that there is a one-in-three chance of your corpus being lower in a year’s time, irrespective of how long you remain invested. Comparatively, the chances of incurring a loss over a three-year horizon is far lesser. “Checking just a year ahead for vital, non-negotiable goals is a big risk. So don’t wait until a year before your goal. Find out where your corpus stands vis-à-vis the target amount three years before the goal date,” suggests Bala.

At this time, your action plan should be based on the shortfall against your target corpus. If your corpus has already hit or is reasonably close to your target, you can afford to exit the fund outright and switch the entire sum to FDs or liquid funds to keep the pot secure. There is little merit in setting up an SWP for a calibrated exit. If three years ahead of the goal date, you find that your pot is still some way off the target, set up an SWP to start securing portions of the corpus, while letting the rest grow to cover the shortfall. Avasthi reckons the run-time for an SWP can stretch over 2-3 years before the goal due date for investments that have been running for over 15-20 years. But for investments running over a shorter horizon, the SWP period must not exceed 12-18 months. “If the accumulation phase is only 7-10 years, running an SWP for the last three years may prevent adequate compounding of wealth,” argues Avasthi.

SWP protects you from extreme outcomes
Exiting your investments via SWP would have saved your returns in 75% of the instances when the markets were down.

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Data considered from 1 Jan 2002 to 31 Oct 2023 for Nifty 50 TRI
Source: Edelweiss MF

For negotiable goals that can be pushed back by a few years, such as buying a car or taking an overseas tour, you may keep things fluid. Even if the market happens to decline during this time, you can afford to extend the SWP run-time and wait for the recovery in value. “If you are confronted with a goal year where the market falls sharply, wait it out if the goal is negotiable by a year or so. Otherwise, exit in a phased manner, giving an opportunity for the portfolio to recover,” says Bala.

Which funds are suitable?

SWP outcomes may vary greatly depending on the type of fund you are drawing from. Ideally, you must avoid setting up an SWP from a fund exhibiting high volatility. The SWP route will not protect your corpus from eroding when exposed to the market’s vagaries. It will only slow down the decay to some extent. If the NAV on the date of redemption is low, then more units get redeemed. If the market decline continues, the available units will deplete fast, and the entire corpus will get exhausted sooner than anticipated. This makes any equity and equity-oriented fund unsuitable for SWP. “Never try to rely on SWPs from pure equity funds if you require regular income and don’t have a very large initial corpus to begin with,” insists Dev Ashish, Founder, StableInvestor. He further points out that it can be very tough emotionally for most investors to see their portfolio going down sharply, even temporarily, when they are withdrawing from it.

Deferring SWP by a few years yields superior outcomes
It allows for growth in initial capital and prevents withdrawals from eating into the capital sooner.

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Data as on 31 Oct 2023 for Nifty 50 TRI. Investment date considered as 1 Jan 2010 and monthly SWP considered on first business day of the month. Investment: Rs.10 lakh, monthly withdrawal: Rs.10,000 | Source: Edelweiss MF

However, if the runway for your SWP is sufficiently long, it may be prudent to have a portion of the corpus lying in an equity-oriented fund. This will allow your initial capital to appreciate, even as you take money out at the other end. To squeeze more out of the SWP, experts suggest that you follow a two-bucket strategy. According to this approach, a safer debt fund can be paired with a hybrid fund that has an equity component. The money that you need over the next three years can be parked in a liquid or an ultra short-term debt fund. The remaining money can be kept in a dynamic asset allocation fund or even a multi-asset fund. You initially set up the SWP from the hybrid fund, but drawing from this fund during sharp market declines is not prudent. “To avoid taking a hit at such times, investors can temporarily stop the SWP from the hybrid fund and start drawing from the debt fund. Once the market recovers, the investor can restart the SWP from the hybrid fund,” suggests Kumar.

Don’t wait till the last year to exit
Find out where your corpus stands vis-àvis your target amount three years before the goal date.

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Final word
No matter how you plan it, remember that an SWP won’t ensure you reach the target amount. When you plan your exit via an SWP, you are simply de-risking your target outlay. It will simply ensure that you don’t exit at the bottom. At the same time, you won’t sell out at the top either. But then, a well-timed bullet withdrawal is possible only in hindsight. An SWP moderates extreme outcomes in both directions, and that is a good enough outcome for most of the investors. “The idea behind an SWP is to minimise the regret on the downside while also leaving enough on the table to capture the upside,” remarks Avasthi.

A different spin on SWP
AMCs have designed their own solutions around SWPs. For example, SBI Mutual Fund offers Bandhan SWP, where the amount withdrawn can be directly credited to the bank account of your spouse, parents, children or siblings, thus allowing you to give financial support to your loved ones. A few AMCs now offer a variant of SWP, where instead of a regular fixed payout, investors can withdraw a fixed percentage of the investment. So, if a person has invested Rs.25 lakh and opts for a monthly payout at the rate of 10% per annum, he will get Rs.20,833 per month (Rs.2.5 lakh a year). ICICI Prudential AMC offers Freedom SWP, which, along with a fixed percentage payout of 6% annually, offers investors the option of an additional yearly top-up of 3%, 4% or 5%. A yearly top-up in SWP amount lets you increase your cash flow to stay in step with inflation.



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