Mutual Fund SWP: Smart investment solution for cash flow needs and wealth creation

Mutual Fund Systematic Withdrawal Plan (abbreviated as SWP) is a smart mutual fund investment solution whereby you can invest in lump sum and draw a fixed amount every month (or any other interval). Regular fixed cash-flows will be generated for you by redeeming the units of mutual fund scheme where you had invested in lump sum at applicable Net Asset Values (NAVs) on the withdrawal dates. SWP should be planned with a long horizon in mind, usually 10 years or longer. As long as your withdrawal rate is less than the long term average returns of the scheme, you will not only be able to generate fixed cash-flows but also create wealth(capital appreciation)in the long term.

Benefits of SWP

• Though mutual fund monthly dividend option scan also provide investors regular income (cash-flows), you should bear in mind that mutual fund dividends are paid from accumulated profits of the schemes and are therefore, not assured. Dividend pay-out, both in terms of pay-out rate and frequency of pay-out is entirely at the discretion of the Asset Management Company(AMC).Mutual Fund SWP, on the other hand, assures fixed pay-outs credited to your bank account every month (or any other interval) as long as there are sufficient unit balances in your scheme account.


• SWP from equity or equity oriented hybrid mutual fund schemes is the most tax efficient cash-flow solution in the long term. Profits (if any) in SWP cash-flows are subject to capital gains taxation. Withdrawals from equity or equity oriented hybrid schemes made within 12 months from the investment date are subject to short term capital gains tax, while withdrawals made after 12 months are subject to long term capital gains tax. Short term capital gains are taxed at 15%, while long term capital gains of up to Rs 1 lakh in a financial year are tax exempt. Long term capital gains in excess of Rs 1 lakh in a financial year are taxed at 10%. In contrast, interest paid by fixed deposits, post office monthly income scheme etc. are taxed as per the income tax rate of the investors.
  
  Suggested reading: What are hybrid aggressive funds


• SWP is a highly convenient investment solution. With a one-time SWP registration process, you can setup fixed monthly (or any other interval) cash-flows according to your financial needs. Your financial advisor can help you setup SWP or you can avail the online SWP registration facilities provided by the AMCs.


• Mutual fund SWP is very flexible. You choose SWP amount, frequency and date according to your own convenience. You can also stop your SWP at any point of time, by sending an instruction to the AMC or RTA.

How can SWP generate cash-flows and also create wealth

We will now see how SWP can create both cash-flows for your regular income needs and also create substantial wealth for you in the long term (10 years or longer).

Let us assume you invested Rs 30 lakhs in lump sum in Nifty (Nifty 50 TRI) on 1^st January, 2009 and your monthly SWP amount was Rs 20,000 (beginning February 2009). The chart below shows the results of your SWP from 2009 to 1^st August 2019.

Source: Nifty 50 TRI data from National Stock Exchange

Your cumulative withdrawal over the 10 plus years period was Rs 25 lakhs (from your Rs 30 lakh investment) and yet your wealth (market value of balance units) grew to nearly Rs 78 lakhs (more than 2.5 times of your investment value). This example shows that with SWP you can get fixed cash-flows and also grow your wealth, for reasonable withdrawal rates.

In the above example, we ignored the effect of exit load and taxes. You should plan your SWP in such a way that you can avoid paying exit load for withdrawals made during the exit load period. As mentioned earlier, SWP is the most tax efficient investment solution and you can reduce your tax obligations even further, by planning your SWP in such a way, so as to avoid short term capital gains tax. To know more about the tax implications of your existing or planned SWP, you should consult with your financial or tax advisor.

SWP with annual increase (for inflation)

One of SWP related queries we often get from investors is whether SWP will work effectively if the withdrawal amount is increased every year, to factor in inflation. We think, SWP can work effectively even if you increase your SWP monthly withdrawal amount every year to factor in inflation. Let us continue with our previous example and factor in 6% increase in SWP monthly withdrawal amount every year (assuming 6% average CPI inflation rate). The chart below shows the results of your SWP from 2009 to 1^st August 2019, factoring annual increase in SWP withdrawal rate (@ 6%).

Source: Nifty 50 TRI data from National Stock Exchange

Your cumulative withdrawal over the 10 plus years period was Rs 34 lakhs (more than your Rs 30 lakh investment) and yet your wealth (market value of balance units) grew to Rs 65 lakhs (more than 2 times of your investment value). This example hopefully, demonstrates the power of SWP in generating income (factoring in inflation) and also substantial capital appreciation, provided you have a long investment horizon in mind.

Reasonable withdrawal rate is important

The most important success factor for your SWP meeting your cash-flow and wealth creation goals is a reasonable rate of withdrawal. In our around 6 - 7% withdrawal rate which on post-tax basis yields higher post income than bank FDs is ideal for SWPs. There are several examples of mutual fund SWPs which have given good results with slightly higher withdrawal rates, but investors should be conservative to start with and set their cash-flow expectation with post tax FD interest rates. You can always increase your withdrawal rate later, if your investment is appreciating in value.

Conclusion

In this blog post, we tried to demonstrate how SWP can be an extremely effective solution for meeting your regular cash-flow needs and also generate substantial wealth for you in the long term. You should also note that in this post, we used a market index, Nifty Total Returns Index as our investment proxy; actively managed mutual fund schemes aim to beat the market and therefore, you can expect even better results with mutual funds having strong performance track records. As mentioned in the previous paragraph a reasonable withdrawal rate is important for the sustainability and success of your SWP. You should also factor in exit load and tax consequences when planning your SWP. You should always consult with a financial advisor, if you need any clarification or help with your investment planning.

You may further read: How SWP from Balanced Mutual Funds can be useful to get regular return