During a discussion, a friend mentioned that he was looking for a regular income and wanted to set up a Systematic Withdrawal Plan (SWP) to generate such income.
He asked me the equity fund (from his existing portfolio) where he should set up a SWP. I told him the approach could be risky. He couldn’t understand why. After all, he has been investing through SIP for many years with reasonable success.
I told him SWP is exactly the reverse of SIP. What works with SIP can go against you in case of a SWP.
SWP is different from a SIP
With SIPs, rupee cost averaging works in your favour i.e. you accumulate more units when the markets are down and less units when the markets are up. Hence, market volatility can be your friend in such a case (if you are investing for long term).
Read: Myths surrounding SIP
With SWPs, rupee cost averaging works in reverse. You sell more when the markets are down and sell less when the markets are up. This way, your portfolio can deplete much faster than expected.
Wouldn’t you want to sell more when the market is high and buy more when the markets are low? With SWP, exactly the reverse happens.
Let’s try to understand with the help of an example.
Suppose you invested Rs 1.2 lacs in a Nifty index fund (or ETF) on March 1, 2015 that replicates Nifty performance exactly. NAV of the fund is say Nifty Value/100. So, if the Nifty is 8000, NAV of the fund will be Rs 80 per units.
Your intent is to withdraw Rs 10,000 per month from this corpus for the next 12 months (on 1st of each month from April 2015 till March 2016). With Rs 1.2 lacs at your disposal for requirement of Rs 10,000 per month for 12 month, you can even do this at 0% return. Even if you keep this amount in savings bank account, you will have some change left after drawing 12 installments.
To sum up, the cash position is quite comfortable.
In the example, if the markets were closed on a particular day, I have taken NAV for the next working day. I have not considered the impact of exit load and capital gains tax.
Let’s see how you would have fared.
On March 2, 2015, Nifty was at 8956. NAV would be Rs 89.56. Hence, you will get 1,339.8 units for your investment of Rs 1.2 lacs.
Your corpus didn’t even last for 12 months. You corpus was over within 11 months. Had you kept this corpus in a liquid funds with post tax return of 5%, you would have easily withdrawn 12 installments of Rs 10,000 and still be left with little over Rs 3,500.
Who was the culprit?
Market volatility and your luck. And you can’t control either.
You started on a bad note. Your corpus went down almost 4% before you made even your first withdrawal. Within two months, even though you had withdrawn only Rs 20,000, your corpus was down by already ~Rs 28,000.
In a decumulation portfolio (like in this example), sequence of returns is also quite important. If you get a bad sequence of returns to begin with, it may be difficult to recover (even if you get good returns later on). If you are planning to generate income using SWP (from an equity fund) during retirement, do consider this aspect.
The reason is with poor set of initial returns, your portfolio depletes quite quickly.
If you start with Rs 100 and lose 20% on it, you need to make 25% on the remaining Rs 80 just to break even. So, you lost 20% but you need to make 25%. Add to it regular withdrawals from depleting corpus and you can how odds get stacked against you.
At the beginning, you had Rs 1.2 lacs for 12 months. And the situation was comfortable.
At the end of 2 months, you have ~ Rs 92,000 for 10 months. Not so easy now.
You can notice how you have to redeem more units to maintain level of income as the market goes down.
Ideally, you would want to do the reverse. You would want to sell less units when the markets are down and more units when the markets are up.
If the markets had remained flat during the period, you would have redeemed 111.64 units per month. In reality, you had to redeem much more.
I chose the period to suit my argument
Yes, I did. But it does not change my conclusion.
You don’t know upfront how the markets will behave in the next 12 months.
It is quite possible markets would have done well during the period. In such a case, not only would your corpus have lasted 12 months, but you would have also some excess at the period of withdrawal period.
However, when you plan, you do not only consider the optimistic scenario. It is no planning then, it is hope.
You have to be prepared for adverse events.
What should you do?
I am not against Systematic Withdrawal plans but you need to choose the right instrument for systematic withdrawals.
Do SWP from a less volatile debt fund (shorter duration). Move the requisite amount from equity to debt fund and set up a SWP from the debt fund.
You must keep tax considerations in mind. Tax treatment of debt funds becomes benign only after a holding period of 3 years. Additionally, you need to look at your marginal tax rate and decide when to switch from equity to debt.
In my opinion, you must switch from equity to debt fund (for SWP) much in advance. It is like any another goal. As the goal nears, move from equity to debt. Do not leave it for too late.
17 thoughts on “Why Systematic Withdrawal Plan (SWP) from Equity Funds is a bad idea?”
And how about a SWP which is based on units. 50 units sold 5 a month over 10 months, when the market is priced optimistically. Certainly a good sell
In number of units, the income won’t be constant.
Didn’t really get “When the market is priced optimistically” part? Can you please elaborate?
Superb Deepesh completely agree; one new learning for me.
But how to get maximum return in this situation
Mr. A is investing 20 k/month through SIP in ELSS funds.
At this moment Mr. A is not having any home loan but he will have it in next 2 years. So he is thinking to redeem his ELSS once lock in period of 3 years is completed & pay home loan early (off course after calculating tax benefit of principle & interest).
He can not withdraw his whole ELSS investment in one go as he is doing SIP & every SIP is locaked for 3 years. So he is having 2 option
1. Start SWP by considering lock-in period & pay loan by increasing EMI by amount of SWP
2. Wait till his all ELSS funds completes 3 years (around 5+ years waiting time )lock-in period & pay loan in bulk
What will be your preferred way of handling this situation ?
Thanks Sanket!!!
The money that you need after 3-5 years shouldn’t be in an equity fund in the first place.
Moreover, there are practical issues with this approach.
What if the markets are down at the time of drawal and the unlocked units are not enough to reach the monthly income.
Hence, SWP cannot simply work in such a situation.
If you wish to prepay loan, consider your finances and the asset allocation at the time and take a call.
You are right Deepesh,
Money needed after 3-5 years should not be in equity funds.
But consider everything went well & capital invested is safe then I guess there is no harm in withdrawing ELSS funds after 3 years lock in period even though it is in Equity.
Again loan prepayment is just cherry on a cake; if you can grab it then good if not then well n good. So it doesn’t matter unlocked units are enough or not.
I just wants to highlight that in personal finance you can not apply any hard & fast rule like switch to Debt funds from Equity & then start SWP.
Anyway very informative & valuable discussion.
Thanks.
Sanket,
I have a limited point. If you are sitting on gains and want to use the funds for something else, redeem the units and use it for the purpose. SWP may not be the best choice in case of equity funds.
Example given above is not an ideal one to justify your own assumption. One should not draw 8-8.5% of principle annually. If you provide a real life example with a top rated Balanced fund for a span of 3-5 years then the scenario is totally different altogether.
We can always choose different examples (and perhaps better examples).
However, the basic concept of sustained withdrawal from a very volatile investment is in principle flawed.
Withdrawals from a falling investment will only accelerate depletion of the portfolio.
Too tricky for a retirement portfolio.
You can always get lucky though.
Dear Deepesh,
This is classic example where many people failed to judge the sequential risk.
As I understood well then, your suggestion is that everything is depend upon the goal, and due to tax issue and due to 3 years periods n debt instruments, SWP would be beneficial after 3 years.
Therefore,
1) In 3 years away from your goal , redeemed from equity( in one shot) to debt and then 3 years later start SWP from debt.
or
2) In 3 years away from your goal , start SWP redemption( for 3 years) from equity to debt and then 3 years later start SWP from debt?
Please provide your reflection what approach would be best lump some from equity to debt or SWP from equity to debt and swp from debt…
Looking forward for more details insight….
Thanks…..
Dear Dilip,
Well, the exact strategy may depend on a lot of things.
I will gradually start moving from equity to debt many years before (and not wait for the last 3 years).
For regular income, swp will be from debt funds.
Dear Deepesh,
I appreciate once again for your response.
I have indeed started digging further exploring and found one of the detailed analysis on one for the following blog and that was evident of what has I presumed to exit from equity, that is…find here…is the example…
https://www.advisorkhoj.com/articles/Mutual-Funds/Best-Mutual-Funds-SWP-returns:-Superb-performance-by-DSP-BlackRock-Top-100-Equity-Fund
This is giving and exactly different direction.
Do you have further reflection ?
Thanks…
Dear Dilip,
You can safely ignore such shallow articles.
If you pick date, time and fund to suit your argument, you can prove anything.
Why an NFO? Why a fund that started in 2003 and not in 2007? Just to prove your argument.
With the gift of hindsight, you can make data to confess to anything. 🙂
Equity is inherently volatile and systematic withdrawal from a decumulation portfolio can only accelerate depletion.
Nothing can take away that risk.
It is the articles like these that investors need to guard against. Can do a lot of damage.
you can make a lot of money by going to a casino. That does not mean going to a casino is a wise financial choice.
Dear Deepesh,
Thanks for your direction and view point with comparing the ultimate example of casino..
I think there are two factors(Corpus and withdrawal %) which governs in both the examples for its correctness.
If in your example : is portfolio value consider to be of 10 or 20 times times meaning 12 lacs or 24 lacs will run appx. 10 years to 20 years – Right ? since then the equity is for long duration and withdrawal % will be lessen, it might not impact more due to market recovery phase. within 10/20 years period.
What I have learned that from equity withdrawal is dangerous in case of short term(1 year) withdrawal, so to compensate the volatility factor…..
1) .in bear market .increase portfolio value and reduce the % withdrawal.
2) In bull market reduce portfolio value and increase % withdrawal.
Thanks for sparing your valued time in response so far.
Looking forward for more interaction likewise in future.
Thanks.
Hi Dilip,
I get your point.
Adjusting withdrawals in bear and bull markets may not be that easy. You can cut down discretionary expenses but can’t cut down non-discretionary expenses.
If the investor has a lot of money, he can choose to do anything. Hopefully, he will have to enough for life despite making poor choices.
Irrespective, SWP from an equity fund for retirement expenses will always remain a risky approach. There will be a huge sequence of returns risk. It is another matter that the risk may not materialize.
The problem with withdrawal from a very volatile decumulation portfolio is that your losses become permanent. That is not the case with an accumulation portfolio.
Request you to go through the following post.
https://www.personalfinanceplan.in/opinion/financial-planning-retirement/
Nice article, But don’t know how to get in touch with these professional advisor. i have done some on my own hope it work.
Hi Sam,
Please work with a SEBI Registered Investment adviser.
If I withdraw about 8% (that makes it an annual withdrawal of Rs. 9600 in your example) would we have the same result? In your example, you withdraw too much too soon. Why don’t you show us what happens to the corpus of Rs. 1,20,000 if we annually withdraw Rs. 9600 from it? Extend your example over any ten historical years and let us see the results.
I think the result of such an experiment would be very different.