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Systematic Withdrawal Plan (SWP) – Avoid timing the market while selling and get regular payouts

Timing the market is a futile effort – both while buying mutual funds (Mfs) and selling. Here is how you can avoid timing the market while selling your units and gain from cost averaging.

You know that there is no way you can perfectly time the market while purchasing your mutual fund (MF) scheme units. That’s why you use Systematic Investment Plans (SIP) offered by the fund houses.

By using SIPs, you not only remove the element of timing the market, but also benefit from rupee cost averaging.

 

Can you avoid timing the market while selling?

But all this is true at the time of buying the MF units. What about selling the units?

Is there any way you can avoid timing the sale of units? Is there any way you can benefit from the same cost averaging principle while selling your units?

Yes, there is – through a Systematic Withdrawal Plan (SWP).

 

What is a Systematic Withdrawal Plan (SWP)?

Just like Systematic Investment Plans (SIPs), most mutual fund houses also offer Systematic Withdrawal Plans (SWPs).

Through SWPs, you can withdraw your money gradually from an MF scheme – instead of redeeming all units at once, you redeem your units over a period of time. Thus, you avoid timing the market and benefit from cost averaging.

 

How does a Systematic Withdrawal Plan (SWP) work?

When you opt for a Systematic Withdrawal Plan, you tell the MF company that you want to withdraw a fixed sum every month / quarter.

At the specified date, this fixed amount is converted into equivalent number of units as per the prevailing Net Asset Value (NAV) for the MF scheme. These units are then redeemed from your account, and the money is given to you.

 

Example

Let’s say you have 1,000 units in an MF scheme. You have given a mandate to the fund house that you want to withdraw Rs. 2,000 every month through SWP. On 1 January, the NAV of the scheme is Rs. 15.

Equivalent number of units = Rs. 2,000 / Rs. 15 = 133.33

Thus, 133.33 units would be redeemed from your MF holdings, and Rs. 2,000 would be given to you.

Your remaining units = 1,000 – 133.33 = 866.67

Now, on 1 February, the NAV is Rs. 16. Thus,

Equivalent number of units = Rs. 2,000 / Rs. 16 = 125

125 units would be redeemed from your MF holdings, and Rs. 2,000 would be given to you.

Your remaining units = 866.67 – 125 = 741.67

 

Advantages of a Systematic Withdrawal Plan (SWP)

As we have seen, SWP helps you avoid timing the market. You also benefit from cost averaging. Apart from these, there some other advantages as well.

 

Regular income

When you opt for SWP, you get a fixed amount periodically – say monthly or quarterly. Thus, SWPs are a good way to ensure that you get a fixed amount as per your needs.

 

Booking profits periodically

Many MF houses also offer SWP with a feature that allows you to withdraw only the gains or appreciation made in the units. Thus, when you choose this option, you book your profits while still retaining your capital in the mutual fund scheme.

This option would be more useful when you have chosen the “growth option” in the MF scheme, as profits are automatically booked in the “dividend option” in the form of dividend distributions.

(Please read “Mutual Funds – Growth or Dividend option?” for more on these options)

 

SWP and Income Tax (IT)

Capital gain tax – either short term or long term – would be applicable on withdrawals made through SWPs just like regular redemptions.

(For more on capital gains tax, please read “Long Term and Short Term Capital Gain – Income Tax Calculation“)

 

Is SWP right for you?

Ideally, any investment in MFs should be withdrawn over a time using SWPs instead of making lump sum redemptions.

A Systematic Withdrawal Plan is also good for anyone who needs regular periodic income. So, you can opt for SWP if you need a fixed amount say every month.

Please note that this amont is generated by diluting your units and is not any kid of guarantee of returns. These are withdrawals, and not just profits. If the mF scheme doesn’t make profits, or if the profits are less, you would still get the fixed amount specified by you – in such an instance, your capital (amount you have originally invested) would be depleted.

SWP is also good for retirees – if you have retired and need regular income, you can opt for a Systematic Withdrawal Plan.

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