What is a Systematic Withdrawal Plan?
A Systematic Withdrawal Plan is a method of completely or partially withdrawing stock market investments in a periodical manner.
Just like investors build their investments regularly with an SIP, they can redeem investments regularly with an SWP.
Investments can be redeemed on a monthly, quarterly, half-yearly, or yearly basis.
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These withdrawals are made on the basis of an amount specified by the investor.
Once an amount is set, the fund will sell the required number of units, as per NAV, to give back the specified amount to the investor.
Why should an investor use an SWP?
Using an SWP allows an investor to reap the benefits of investment over a prolonged period, rather than all at once.
SWPs can be an essential element of financial security and retirement planning, as they can help create a stream of regular income.
Also, many investors look for investments which can create a regular income for them.
Instead of opting for dividend-paying investments compulsorily, they can simply invest in any mutual fund of their choice, then set up an SWP.
Now, let us understand the working, advantages and disadvantages of using Systematic Withdrawal Plans.
How does a Systematic Withdrawal Plan work?
Let us understand the systematic withdrawal plan with the help of a practical example.
Suppose an investor has a lump-sum investment of ₹50,000 in a mutual fund, purchased at a Net asset value(NAV) of ₹100.
Now, they decide to use an SWP to redeem it.
Suppose they choose to withdraw ₹5,000 monthly, for the next four months.
Here is what their investment will look like at the end of the five months –
As it can be observed, as the NAV fluctuated, a suitable number of units were sold to give the investor ₹5,000 monthly.
Therefore, by redeeming the investment through an SWP, they now have 300 units remaining at an investment value of ₹30,000.
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₹20,000 have also been successfully withdrawn over the last four months, irrespective of any changes in the value of the units.
Now, with this table in mind, let us discuss the pros and cons of using Systematic Withdrawal Plans.
What are the Advantages of Systematic Withdrawal Plans?
- SWPs provide the benefit of rupee-cost averaging. Investors can sell more units when the NAV is low, and less when the NAV is high.
- Investments are less affected by market volatility, thus assisting wealth creation on a long-term basis.
- A Systematic Withdrawal Plan helps set up a regular stream of income from mutual fund investments.
- As mentioned before, withdrawals will not depend on the NAV; rather they will be made as per the amount mentioned by the investor.
- Setting up an SWP stops investors from making impulsive selling decisions out of fear in the market, thus teaching financial discipline and patience.
What are the Disadvantages of Systematic Withdrawal Plans?
- SWPs are more suitable for people approaching retirement, as they need to focus more on regular income than long-term investing.
- SWPs can erode our overall capital in a bearish market. More units of the fund will be sold when the NAV is low, thus leaving an investor with lesser capital after the SWP is stopped.
Systematic Withdrawal Plans are a great way to build a regular stream of income.
What’s more, an investor can simultaneously set up an SIP on one mutual fund, and an SWP on another as well.
This can be done to keep building the capital while creating a stream of periodical income.
Before an SWP is set up, it is essential for any informed investor to carry out proper market research and understand how the SWP will help them to achieve their objectives as well.
Doing so can ensure that setting up an SWP can give any investor maximum benefits.
Key Takeaways:
- A systematic withdrawal plan can be used to make regular withdrawals from a mutual fund investment.
- SWPs provide investors with a regular stream of fixed income, irrespective of a fluctuating NAV.
- SWPs have many benefits that make them a suitable tool for goal-based investing.
Happy Learning!
