Here’s how you can Understand & use SWP effectively
The four pillars of personal finance are Assets , Liabilities , Income and Expense.
Planning for your expenses or cash outflows are a vital component of your financial plan. Because of a range of reasons like inflation and anticipated and unanticipated exigencies regular Cash flow is vital for a smooth life. It is rightly said that in Business Working Capital is like blood to the business. Similarly it is vital for our personal finances too .
If you are looking for regular and predictable cash flow from your investments then the automatic choice for most of us would be the traditional avenues like bank FDs and postal deposits ( and Pension/ annuity plans if we are lucky to have planned for them) . However, the falling /low-interest rates on these schemes and inflation have made people worry about their future. The big questions are, will the cashflows it be sufficient and how long will the investment last?
Against this backdrop, Systematic Withdrawal Plans (SWPs) offered by mutual funds are increasingly gaining popularity and can be a great choice for investors looking to generate regular cash flow from their investments .. In this post, we shall seek to give some insights about SWPs.
What is SWP?
The SWP (Systematic Withdrawal Plan) is like the reverse of the popular concept of SIP wherein instead of investing money at regular intervals, investors withdraw/redeem a fixed amount from a scheme (in an automated way).
The SWP serves as a very good tool for planning for that phase in your life where you are dependent on regular cash inflows, for whatever reason. Here, the investor would typically make an initial investment in the chosen fund and then plan for SWP, either immediately or defer it to a later date. The investor has the flexibility to customize the amount as per their requirement, the withdrawal frequency, the period of withdrawal – whether fixed instalments or till the withdrawable balance is available in the fund. The investment lying in the fund would continue to grow, generating wealth for the investor, helping beat inflation and making sure that the fund lasts longer and the SWP continues for a longer period of time. The SWP is also a smarter and more tax-friendly way of withdrawing money. The growing corpus is also a good Estate Planning tool while the regular withdrawals ensure liquidity during lifetime of the investor.
When can SWP be used?
Typically SWP is a great tool to use in the following scenarios
1] Retirement planning /creating own pension/annuity
A very common use of SWP is in retirement planning. Here, a part of the retirement corpus is invested in a chosen Mutual fund scheme, typically with a mix of both asset classes - equity and debt, giving the best of both worlds. The equity is for the long term, for that extra boost of growth and the debt is usually for short-term safety. The choice of the fund category and scheme, however, depends on your needs, the risk profile, and the investment horizon, before the start of SWP.
2] Creating a secondary source of income
A SWP can also be started in situations where there is a temporary need to supplement your income, for example like the recent pandemic. If you have adequate investments, an SWP could be used to meet your temporary financial needs. Also, instead of withdrawing a big amount in one go, one can smartly use SWP to maintain some stability in your inflow .
3] Meeting specific cashflow needs for someone
Another smart use of SWP would be in scenarios where you invest for a specific objective/regular expense and an SWP is created to take care of that. The corpus would keep growing slowly while small withdrawal amounts would be credited to the bank account and from this, the intended expenses would be met. As an investor / donor , all you need to do you would only need to keep track of the fund balance from time to time and replenish it, if required. There can be many scenarios where such an approach can be used in financial planning. A few examples are cited below.
- SWP for education fees and pocket money of Children
- SWP for monthly household expenses, etc.
- SWP for meeting regular expenses of dependent parents
The right withdrawal rate :
This is an interesting question. What should be your sustainable or safe rate of withdrawal in order to make sure that your fund lasts for the required period of time and even longer? A complementary question would be, what should be my investment corpus to have the desired stream of money last for the required period of time? This is in fact at the heart of everyone trying to retire early and for those who are reaching retirement soon.
The withdrawal rate is the percentage of corpus you intend to withdraw every year. So a 5% rate on a corpus of Rs.50 lakhs would mean that you are withdrawing Rs.2,50,000 every year (Rs.20,833 monthly). Obviously, the lower the withdrawal rate and the higher the investment corpus, the better. Also, the expected returns from the fund also matter in replenishing itself and growing to finance withdrawals for a longer period of time. While a rate of up to 5-6% may be considered safe, a lower rate can help account for market volatility, uncertainties and lifestyle improvements. The withdrawal rate should be as per your need - a higher rate would mean that your corpus gets exhausted early and a lower rate would be insufficient. It also helps to invest and let the Corpus grow for some time before starting the withdrawals.
In Conclusion
SWP is an efficient tool and optimal way to plan for regular cash inflows. However, one must be careful and keep the financial objectives in mind. Remember, unplanned and unnecessary SWPs can cut short your wealth-creation journey. It is rightly said that compounding is the eighth wonder of the World and SWP is a need based tool to be used prudently.
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