Smarter ways to use Systematic Withdrawal Plan (SWP) in mutual funds
Systematic Withdrawal Plan is opposite of Systematic Investment Plan (SIP). Systematic Withdrawal Plan(SWP) is where an investor would withdraw a fixed amount in regular intervals like every month or every quarter from their mutual fund investment. While SWP concept is familiar, do you know that there are smarter ways to use the Systematic Investment Plan to get higher returns from your mutual fund investment?
How exactly Systematic Withdrawal Plan works?
Let me explain this with an example.
An investor has 10,000 mutual fund units of a mutual fund scheme, where the mutual fund NAV is Rs 20.00 and the total value of the mutual fund units is Rs 200,000. Now with a systematic withdrawal plan he wants to withdraw Rs 5,000 every month. First month he withdraws Rs 5,000 (Rs 5,000 / Rs 20 NAV = 250 units). The balance units available would be 9,750 units @ 20.00 = Rs 195,000. Second month, assuming that the NAV is Rs 20.15, the amount he withdraws is Rs 5,000 (Rs 5,000 / Rs 20.15 = 248.14 units). The balance units available are 9502.86 @ Rs 20.15 = Rs 191,462. If you observe that out of a total investment of Rs 200,000, the amount withdrawn of Rs 10,000, the balance should have been Rs 190,000. However, with a systematic investment plan the amount of balance is Rs 191,462 thereby gaining of Rs 1,462 in 2 months. This example is illustrated assuming that the market is rising and hence the NAV has increased. In a growing market, systematic withdrawn plan works well.
What are the Benefits of Systematic Withdrawal Plan (SWP)?
There are various benefits of systematic withdrawal plan:
1) Rupee-Cost averaging: With rupee cost averaging out in a growing market, the longer the systematic withdrawal plan, the more you benefit from such approach.
2) Tax advantage: In case you are withdrawing the amounts invested in mutual funds within 1 year, it attracts a short term capital gain. However, with a systematic withdrawal plan, the amount which you are withdrawing would be in smaller amounts and all amounts withdrawn in the first year would be the capital itself. Hence it would not attract tax in case you are withdrawing through SWP.
Why SWP is used in mutual funds?
While regular income comes from Salary, business income, FD interest, pension, etc., Systematic Withdrawal Plan is used to supplement regular income.
5 Smart ways to use Systematic Withdrawal Plan in mutual funds
1) Retirement Plan through SWP
2) Disciplined withdrawal savings through SWP
3) SWP through Monthly Income Plans
Do you know that investment in Monthly Income Plan (MIP) Mutual Funds would provide regular income to you. But if you can invest in growth option of MIP and withdraw fixed income through SWP, you would gain more. The higher the term of investment, the higher returns you would benefit. This is a better option than POMIS or dividend option of MIP Mutual funds. MIP mutual funds provide 8% to 11% annualized returns, hence these are better than POMIS or bank FD’s. Investors can select top MIP Mutual funds like HDFC MF MIP or SBI Magnum MIP etc.,
If you are a low risk taker, the best way to invest your lump sum money is investing in long term debt mutual funds. You can do SWP from debt mutual funds and withdraw at regular intervals. While you would get 8% to 10% returns, you would enjoy much higher returns through this approach.
5) SWP through Hybrid funds are more efficient
In a recent analysis from from one of the top financial website, SWP from Hybrid funds are better in 5 to 8 years period than SWP in debt funds or SWP from equity funds. Hybrid funds invest 65% in equity and balance in debt related instruments, hence downside is limited compared to equity funds. Hybrid funds have been performing well and gave 12% to 16% annualized returns in last 8 to 10 years. If you can take some risk, invest in hybrid funds and SWP to withdraw your mutual fund investment at regular intervals.
Conclusion: Longer you stay in mutual funds, you would benefit more. Use SWP only to supplement income and not for regular income. If you want to utilize SWP for short term, invest in liquid and ultra short term debt funds and do SWP. If you want to use SWP for medium to long term, better to invest in hybrid/balanced funds or long term debt funds and do SWP at regular intervals.
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Smarter ways to use Systematic Withdrawal Plan in mutual funds