Last week, I came across an advertised from SBI Mutual Fund in ET Wealth where the AMC extolled the virtues of Systematic Withdrawal Plan (SWP) from an equity mutual fund.
Through an illustration, SBI AMC tried to demonstrate how a SWP from an equity fund is a better choice than fixed deposit for regular income.
One of the excerpts in the ad was “Traditional Saving Instruments are taxed at a higher rate as compared to equity-based mutual funds with SWP Facility.”
I have written about why SWP from equity mutual funds is a bad idea before. However, this advertisement made me revisit this topic and point out the fallacies in the AMC’s argument.
What was the advertisement about?
You invest Rs 50 lacs each in an equity mutual fund and a bank fixed deposit. Equity mutual funds provide market linked returns while bank fixed deposit gives a fixed 7.2% per annum.
You withdraw Rs 30,000 from an equity fund per month. In case of bank fixed deposit, the monthly interest (at 7.2%) will be Rs 30,000.
Therefore, the pre-tax income from both investments will be Rs 30,000.
Image: ET Wealth
You get better cash flow in case of equity fund SWP. Over the year, you pay capital gains tax of Rs 3,233. Your net cash flow for the year will be Rs 3.57 lacs (Rs 3.6 lacs – Rs 3,233).
An investor in 30% tax bracket pays income tax of Rs 1.11 lacs (at 30.9% tax rate). Therefore, the net cash flow for the year is Rs 2.49 lacs.
Net cash Flow: Rs 3.57 lacs (for SWP from equity funds) vs. Rs 2.49 lacs (from bank fixed deposit)
You pay much lesser tax in case of equity funds.
Moreover, in the case of equity funds, you still have Rs 52.35 lacs at the end of the year.
In case of bank fixed deposit, you are left with the principal amount Rs 50 lacs.
Therefore, in case of SWP from equity funds, you get better cash flow, pay lower tax and end up with a higher corpus.
What else do you need?
Does that make SWP from an equity fund a good choice?
No, it does not. In this post, let’s see why.
What are the flaws with the approach?
It is assumed that the investor falls in the 30% tax bracket. Could have been in a much lower tax bracket. For instance, if you fall in 20% tax bracket, you total tax outgo will only be Rs 74,160 (in case of fixed deposit). This is not as important though.
Exit load period has been ignored too. However, focusing on exit load will be a digression from the base topic.
Now, the most important aspect.
SBI MF picked up a period where equity markets have done well. The AMC picked up a period from May 1, 2016 to May 1, 2017 when Nifty has gone up from 7806 to 9313, a gain of 19.3%.
Either the marketing department at SBI AMC is quite incompetent and does not even understand the impact of a market upswing in a SWP or quite smart to pick a period where the markets have done well. I am quite inclined to feel that they are quite smart.
Now, let me pick up a period for this SWP.
I pick up SBI Blue Chip Fund for this investment of Rs 50 lacs. You open a bank FD at 7.2% per annum. You make the lump sum Investment on March 1, 2015 and take income for the next one year.
After 1 year, you end up with Rs 41.68 lacs in case of SWP from equity funds. With a fixed deposit, you still have Rs 50 lacs with you.
Of course, you may have to withdraw more from fixed deposit to match the cash flow of SWP (but that’s not the point here). Almost 19% of your portfolio is already gone. Imagine the mess if it happens during retirement.
That you accumulated short losses of ~ Rs 11,000 looks penny change as compared to depletion of 10 of your portfolio.
You can argue I have chosen a period where equity markets have not done well. For this, I can only say the following:
- The market returns have not been as bad. The markets can give much worse returns.
- You do not know upfront what kind of market performance you will witness over the next 1 year or the next few years. While making investments, you have to make sure that a bad market phase does not kill you.
- The above point assumes even greater importance if you are relying on the corpus for the income (say, during retirement). With SWP, rupee cost averaging can work to your detriment. As you can see, as the NAV goes down, more units have to be sold to maintain the level of income. I have discussed this aspect in greater detail in this post.
Is Systematic Withdrawal Plan a bad idea?
No. Far from it.
Systematic Withdrawal Plan is not a bad idea per se. SWP from an equity fund is.
You can always get lucky (as in the illustration used by SBI AMC) but that is not guaranteed. Such a decision can backfire (as shown in the example I considered). Sequence of return matters, especially you are relying on your investment for regular income.
SWPs can be used smartly to generate tax-efficient income. However, you must use SWP only from debt mutual funds. The risk will be much lower. Please understand debt mutual funds come with their own set of risks but yes, you can expect volatility to be much lower than equity funds.
Mutual funds are good products. However, it is this myopic approach and shameless and insipid marketing that can be its undoing. You cannot use equity mutual funds for anything and everything.
Equity funds are well-suited to provide growth to your portfolio over the long term but not to provide income in the short term.
If the investors start falling for such ads, they are quite likely to end up disappointed. At some point of time, you will run out of luck.
With SWP, volatility is your enemy and equity investments are inherently volatile. Therefore, the odds are stacked against you.
After all, what matters is how much you got out of a particular investment. You don’t care if the fund gave 15%, 20% or 25% over the last 20 years. Investment returns may be very different from investor returns. If you get -20% during retirement, your financial life may be permanently ruined.
When you evaluate any investment, you consider both risk and potential reward. If reward is seen in isolation, lotteries, derivatives, coin-flips and casino nights will be much better use of your hard-earned money.
You don’t do that, do you?
This is because there is great risk involved. And you assess risk upfront before making an investment, not after getting returns. You decide how much risk you can take and subsequently decide your investments.
By the way, that you got good returns from an investment does not mean there was no risk. There was risk. Just that it did not materialize.
If this (SWP from an equity fund) was a suggestion/strategy by a distributor or advisor, I would have been ok with it. There is bad fish everywhere. But I am not talking about an intermediary.
I am talking about an AMC. With ads such as these, SBI AMC is failing investor trust. This may not be an isolated case. A few months back, I had written about how dividends from a balanced fund were being promoted as source of regular income. Such actions can only give a poor name to the mutual fund industry. I hope these are isolated cases.
To an investor, it does not matter if he/she loses money in MF investments or an insurance policy. A loss is a loss.
Food for thought for the mutual fund industry.
Book Suggestion: Bogle on Mutual Funds: New perspectives from the Intelligent Investor (John C Bogle)
Book Suggestion: Can I Retire Yet? How to make the biggest Financial Decision of the Rest of your life? (Darrow Kirkpatrick)