You can create your own pension or generate a secondary regular income by setting up a systematic withdrawal plan for your mutual fund investments
Systematic Withdrawal Plan (SWP) allows investors to redeem their investment from a mutual fund scheme in a phased manner. According to the investor requirements, the periodic intervals could be monthly, quarterly, half-yearly or annually. On each and every withdrawal, the value of your investment in the fund is reduced by the market value of the units that you have withdrawn. In other words, it is just the opposite of a Systematic Investment Plan (SIP). Let us discuss the advantage of SWP and how you can use the same in an effective manner.
Advantages of SWP
SWP allows investors to customise the cash flow as per their requirements. You can withdraw just the capital gains on your investment or a fixed amount. This way, you have your money invested in the scheme, but are able to access regular income and returns. As SWP redeems mutual fund units at fixed intervals, say monthly, quarterly, etc., irrespective of the market levels, it protects investors from withdrawing large amounts due to panic or fear during the times of market corrections. Let us see some effective strategies of using SWP.
Create your own pension
Through, SWP investors can create their own pension plan. Accordingly, you can create a corpus around two or three years before your retirement and invests the same in a mutual fund scheme according to your risk tolerance. After retirement, you can opt for an SWP on a monthly basis which serves as your own pension.
Generate a secondary income
Given the pandemic, additional source of income is required by almost everyone to manage the rising cost of living and other expenses. Investing in mutual funds and withdrawing via an SWP is a great way to create a regular source of secondary income.
Downside of SWP
Though we have inherent merits in equity fund SWP there are some downside risks like capital erosion which will impact the available corpus. That could probably lead to an investor running out of money well before the target date. Therefore, it is important to fine-tune this strategy to extract maximum benefit especially when you are investing in equity based mutual funds. However, there are certain ways and means through whichyou could possibly avoid such scenarios.
Re-balance at regular intervals
After creating an investment portfolio consisting of equity and debt mutual funds with an intention to go for SWP, it is essential to re-balance at appropriate intervals. By means of periodic re-balancing, investors could book profit when equity valuations are expensive, and they can shift to debt funds. This effectively helps in portfolio protection and enhances the period of cash flows generated from the available corpus. There are significant numbers of dynamically managed asset allocation mutual funds available which do the re-balance on its own based on the pre-determined valuation models. Often such models are time-tested and robust in nature. Further, there is no involvement of investor interference as such funds remove behavioural biases and optimise returns. Investors can thus consider such funds for investment.
To conclude, SIP helps investors to learn the disciplined approach towards investing and SWP helps disciplined withdrawal of the same.
BENEFITS OF SWP
- SWP allows investors to redeem their investment from a mutual fund scheme in a phased manner
- This way, investors have their money invested in the scheme, but are able to access regular income and returns
- As SWP redeems at fixed intervals, it protects investors from withdrawing large amounts due to panic or fear during market corrections
- On each withdrawal, value of your investment in the fund is reduced by the market value of the units that you redeem
The writer is a professor of finance and accounting, IIM Tiruchirappalli