How To Use SWP's Smartly
If you're the kind who habitually flicks on your radio on your way back from work, you've likely heard a recently launched investor awareness campaign by a leading Asset Management Company that extolls the benefits of SWP's or "Systematic Withdrawal Plans". While widespread awareness already exists about Systematic Investment Plans (SIP's), SWP's and their benefits remain relatively obscure in the minds of most Mutual Fund investors. Primarily, SWP's serve two purposes, which are: "reverse" Rupee Cost Averaging from Equity Oriented Funds, and Tax Efficient Income Generation from Debt Oriented Funds.
"Reverse" Rupee Cost Averaging while exiting Equity Funds
Most of us understand the concept of Rupee Cost Averaging by now. Essentially, by regularly making staggered investments of the same rupee amount in a volatile asset class (such as equities), one ensures that the "average" purchase price of their assets are neatly smoothed out over the long run. This protects investors from overcommitting moneys at asset cycle peaks, which happens every so often. But the question of how to efficiently exit an investment in a volatile asset class still looms large. Here's where SWP's could come in handy.
Say, you've been investing in an equity mutual fund SIP for the past ten years, and accumulated an impressive corpus of 25 lakhs, with a sizeable profit component over and above your committed out of pocket capital. You now need to withdraw this corpus systematically to utilize it for a certain goal in the next couple of years (say, your child's higher studies). The NIFTY is closing in on 10K and the house stands divided with respect to where the market is headed from here. Some believe there's another 20% upside in sight, while still others peddle doomsday predictions in the wake of zero earnings growth and the near-term shake-up effect of the GST. What should you do?
This is where you can efficiently use an SWP to benefit from "Reverse" Rupee Cost Averaging. Since you require the cash flows in a staggered manner over the next 24 months, simply instruct your mutual fund company to redeem Rs. 1 lakh per month through the SWP mechanism on a fixed date each month. In this way, you'll average the exit cost of your units and protect yourself from the risk of redeeming everything at a market low.
Tax Efficient Income Generation from Debt Funds
It's an unfortunate truth that dividends from debt oriented mutual funds (which are preferable to equity funds when it comes to steady income generation) are taxed at source at a hefty rate of 28.33%. In effect, for every Rs. 1,000 of dividend declared by a debt oriented mutual fund, only around Rs. 720 will really make it into your bank account. This tax inefficiency makes dividends from debt oriented funds (even MIP's or Monthly Income Plans) a poor income generation strategy - not to mention that the quantum of monthly/ quarterly/ half-yearly dividend itself isn't fixed. Certainly not a good idea for those looking to run their household using these moneys!
A better option exists in the form of SWP's from debt oriented mutual funds. Say, for instance, you've got Rs. 50 lakh to put away for a year, and you'd like to generate income from it. You could select a load-free short-term debt fund with the potential to deliver 8% annualized returns (an amount of Rs. 4 lakh on your corpus). Simply divide this number by 12 and start an SWP for this amount (in this instance, roughly Rs. 33,400).
Here's the good part - you don't need to pay capital gains taxes on the "income" of 4 lakh generated thus, but only on the "profit" portion of the 4 lakhs that you've redeemed (ballpark: Rs. 15000 to Rs. 20000). Even if you fall under the highest tax bracket, your tax outgo on this generated income would work out to barely Rs. 5000 to 7000! Besides the tax efficiency that the SWP strategy affords, you'll also be fixing the monthly amount - and so your cash flows will be completely predictable. A SWP strategy definitely trumps the approach of relying on unsteady, tax inefficient dividends for your monthly income.
