Systematic withdrawal plan in a mutual fund scheme is used to redeem money every month to earn some sort of regular income. But it’s best done from a debt fund, instead of an equity fund.
Of late, there have been many questions from investors regarding systematic withdrawal plan (SWP). The typical question is how to start an SIP (systematic investment plan) and then an SWP from it. There have been some videos floating on social media propagating SWP with enticing numbers. One of the videos talks about investing Rs 25,000 per month for 20 years and then starting an SWP, finally ending up with Rs 7 crore.
Decoding SWP
An SWP is used to get regular amounts from a mutual fund investment. Typically, this has been used by investors like retired individuals who want a regular income from their investments to meet their expenses. In a SWP, an investor sets up a fixed payout at a regular interval (monthly/quarterly) from a mutual fund.
he math behind the influencer videos
Assume:
- Amount invested per month in an equity fund SIP: Rs 25,000
- Period of investment: 20 years
- Rate of return: 12 percent per annum.
At the end of 20 years, the value of the SIP will be Rs 2 crore. Now an SWP is set on this corpus.
- Withdrawal starting after 20 years for a period of 20 years
- Withdrawal per month: Rs 1,50,000
At the end of 40 years (SIP for 20 years & SWP for 20 years), as per this calculation, the investor will be left with Rs 7 crore. Add to that the corpus of Rs 3.6 crore withdrawn, the investor ends up with over Rs 10 crore.
WP is having its moment thanks to these juicy numbers.
But is it that easy to make Rs 7 crore?
Also read | Why systematic withdrawal plans in mutual funds work best for senior citizens
Assumptions and presumptions blur reality
The above calculations assume a 12 percent return on investment, which may happen in the long term but certainly not in a one-way upward direction. It is well known that markets can oscillate wildly in short-term periods and fear tends to manifest itself much more quickly in volatile markets, thus impacting the above calculations negatively.
Second, the calculations make a big assumption that the investor will remain invested for 40 years. As per a SEBI report, in FY 22-23, about 83 percent of mutual fund assets remained invested for 3 years and less and only 3 percent of mutual fund assets remained invested for more than 5 years. This is because investors typically invest intending to make quick returns and also tend to churn funds for the latest well performing funds. Of course, the smallest hint of market volatility makes investors nervous and they pause their SIPs or redeem them. Considering this data, it seems unlikely that investors will hold for a 20-40 year period.
Third, a SWP in an equity fund can be extremely risky due to the non-linearity of returns. If the markets fall 20 percent in the first year and Rs 2 crore becomes Rs 1.80 crore, the entire SWP calculations will go for a toss. Imagine if this downtrend is sustained for a couple of years, how will the investor then manage regular expenses? This is the most misleading of all the assumptions that the above Rs 7 crore calculation has made.
Clearly, the numbers work out on paper, but they do not work out in real life.
Also read | How to make withdrawals under National Pension System
The best way to plan the SWP
The safest option to get regular returns through SWP would be to invest the SIP corpus of Rs 2 crore after 20 years in a debt fund, preferably a short-duration bond fund. Debt funds give stable returns and thus are ideal for SWP. Assuming 5 percent p.a. returns on the debt fund corpus of Rs 2 crore and withdrawal of Rs 1.5 lakh per month, the corpus will last 16 years only. To make the corpus last for 20 years, the investor will need to reduce the payout to Rs 1.3 lakh.
In order to be able to withdraw Rs 1.5 lakh for 20 years, the investor can do the following:
- Invest Rs 25,000 per month in SIP for 20 years. This will grow to Rs 2 crore assuming 12 percent ROI.
- In the 20th year, invest Rs 1 crore in debt fund and set up a SWP and keep Rs 1 crore invested in the equity fund.
- The Rs 1 crore in the debt fund with Rs 1.5 lakh per month withdrawal will last 6.5 years.
- Keep Rs 1 crore invested in the equity fund for 5 years and then for 1 year in the short-duration debt fund. At the end of 6 years, the corpus will grow to Rs 1.75 crore. Now set up an SWP in this debt investment. With a Rs 1.5 lakh month withdrawal, the corpus will last for another 14 years.
Things to keep in mind on SWP
- Always set up SWP in debt funds only.
- Let the debt fund grow for a few years before starting the SWP.
- Remaining invested through the volatility is the key to making the SIP and SWP work.
Take the help of a financial advisor to plan the SWP strategy instead of basing decisions on finfluencer videos which only sensationalise matters without stating assumptions and risks involved.