Most people who invest in mutual funds either sell all of their units or sell a portion of their holdings when it’s time to liquidate. However, many investors are unaware of another redemption option.
Could there be a systematic “withdrawal” technique as well? Absolutely! It is known as SWP or systematic withdrawal plan. SWP is a popular tool used by investors to get consistent returns on their mutual fund investments without having to fully redeem them.
Curious about the Systematic Withdrawal Plan and how it works? In this detailed guide, we will go over the concept, its operation, and whether it is a good idea to do an SWP or not. Let’s begin!
Also read: SIP investment: Your path to wealth building
What is SWP in mutual funds?
SWP’s full form is a systematic withdrawal plan. You may plan your mutual fund withdrawals with the help of a systematic withdrawal plan (SWP). Through this approach, you have the option to decide on the amount and frequency of your withdrawals, which are typically made every month.
The fund house will redeem the required units from your mutual fund holdings once you set up an SWP and credit the funds to your bank account. One may say that this process is the exact opposite of SIP (systematic investment plan).
The primary benefit of a SWP is that it offers a consistent source of income. It’s particularly helpful for retirees and other individuals who need a steady income from their assets. Plus, you don’t have to sell all at once when using SWPs, which might be risky in a down market.
How does a systematic withdrawal plan work?
SWP is an ideal option for those who need to take out a regular amount of money to cover expenses. Here’s how a systematic withdrawal strategy operates:
- As an investor, you must first decide which mutual fund scheme you’d like to invest in and create an account with the fund houses for investments. You decide whether you wish to make lump sum or SIP investments.
- To receive funds into your bank account regularly (typically monthly, quarterly, or yearly), you must set up a SWP.
- The fund house will then liquidate your mutual funds according to the chosen withdrawal amount on the withdrawal date.
- Until you terminate your SWP, the fund house will keep redeeming your unit for the allotted time.
- Depending on how well the underlying assets perform, the remaining amount in your fund will keep generating returns. If you keep making withdrawals, your account balance will eventually drop.
Let’s understand the concept with an example.
In an MF plan, you have 10,000 units. You wish to take out ₹8,000 via SWP each month, and you have instructed the fund house to do so.
In this case, the scheme’s NAV on March 1st is ₹20.
8,000/20 = 400 is the equivalent number of MF units.
You will get ₹8,000 when 400 units are redeemed.
You have 10,000 – 400 = 9,600 units left.
As of April 1st, the NAV is at Rs. 25. As a result, 320 is the same amount of units, or ₹8000/25.
Your mutual fund assets would be redeemed for 320 units, and you would get ₹8,000 in exchange.
You have 9600 – 320 = 9280 units left.
From now on, until all of your mutual fund units are sold, this process will keep going.
Is making SWP in mutual funds a good idea?
The market puts mutual funds at risk, and the government has decided to tax the income that these funds pay. However, with a mutual fund, you may take a certain amount under the SWP, and you only pay taxes on the capital gains component, which could result in less taxes overall.
That said, it would be best if you exercise caution when deciding how much of your monthly investment you want to take out. To safeguard the invested capital, it is suggested to withdraw an amount not exceeding the returns of the scheme.
SIP vs SWP in mutual funds
If you’re looking for a fixed-income investment with solid returns and minimal risk, you may consider SIP and SWP. In SIP, investments are made periodically rather than all at once, while in SWP, withdrawals are made regularly in smaller portions after an initial investment of a lump sum.
In conclusion, if you depend on your savings to cover your expenses, a SWP may be an effective strategy for bringing in additional revenue from your assets. With an SWP, you can also save taxes and preserve your capital with more flexibility.