Three things to know before opting for a mutual fund SWP

A Systematic Withdrawal Plan or SWP allows you to systematically withdraw a fixed amount from a mutual fund in which you have invested, at regular intervals (for example, monthly or quarterly).

While SWPs can come in handy if you need steady cash flow, here are a few things to know before going for one.

Capital erosion

When you opt for an SWP, the cash inflows you receive come from the redemption of your plan units at periodic intervals by the fund house. So, with each passing month, the number of MF units held by you will continue to decrease. For example, you invest Rs. 5 lakh in an MF scheme. If at the time of investment, the NAV scheme is Rs.20, you get 25,000 units. Suppose you start a monthly SWP of Rs. 5,000 a year later. Suppose the NAV is Rs. 25 during the first SWP. To generate the SWP amount, 200 units will need to be redeemed and the number of units you hold will be reduced to 24,800. By the end of next month, if the NAV is Rs.28, then around 179 units will need to be sold for the SWP. At the end of this, the number of units will go down to 24,621 and so on.

If during this period the net asset value of the plan has appreciated, then even if you have fewer units left, your final investment value may still be higher than what you started with. This means that the returns generated by the program will have funded your SWP. But, if the NAV has depreciated or you have been exiting at a faster rate than the NAV has increased, then the SWP will have been funded by your initial investment itself.

Wait

One way to deal with this is to possibly wait a few years before starting a SWP. This can allow your initial investment to grow before you start withdrawing from it. It can also be more tax efficient. When plan units are redeemed for SWP, capital gains, if any, on them are taxed. Capital gains from the disposal of equity fund units held for more than 12 months and debt fund units held for more than 3 years are taxed at a lower rate than when sold within 12 months respectively. and 3 years.

Equity funds versus debt funds

Note that each time the SWP expires, the higher the net asset value of the plan at that time, the fewer units there are to sell and vice versa.

During times when stock markets are up and valuations are high, a SWP can be a good way to earn profits. Also, fewer units will need to be redeemed for the PRS at these times. On the other hand, in a bear market, an SWP’s cash flow will need to be funded by selling a much larger number of units, which is not ideal from a long-term return perspective. Not only that, it can actually be a good time to buy more units and lower your average purchase cost rather than selling units to fund the SWP.

Opting for a SWP from a debt fund may therefore be a better option. Although debt fund returns may not match those of equity funds, they are likely to be less volatile. You might consider, for example, low-duration or ultra-short duration high credit quality funds that derive their returns largely from accrued interest and are relatively less exposed to interest rate risk.

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Dolores W. Simon