The question,“Will my principal stay intact while I do SWP?” surfaced during a discussion on the popular, evergreen theme — systematic withdrawal plans (SWP). The interlocutor was a retired man, a former blue-collar job-holder who has spent much of his adult life working hard, while assiduously saving his pennies. A typecast individual whose systematic investment plans (SIPs) have largely borne fruit.
“Let us consider SIP and SWP as two branches of the same tree, going in opposite directions,” I tried to bring in an arboreal analogy while stressing on the word “opposite”. We can view SWP as ‘reverse SIP’, what we save via SIP during our working years can be withdrawn via SWP once we superannuate. Retired or not, this can be done in an organised manner, I told him, before turning my attention to the primary question, adding that principal will remain intact till the time gains are exhausted.
For the average investor, therefore, the rate of withdrawal must not be higher than rate of growth of residual units. Let us assume that your rate of growth is X per cent and rate of withdrawal is Y per cent. So if (X > Y) is a decent figure, you will be quite safe.
The dynamics of SWP
SWP is easy to understand provided you are comfortable with its central theme. View this against the concept of SIP, the most efficient way of creating wealth. This is a meaningful way to build assets, especially for small investors who are willing to contribute tiny amounts of money over time. Such investors are generally well aware of the realities — their goals, once reached, will spell an end of sorts. Or they may attain retirement age and stop earning actively. Their plans must now accommodate the other critical question: how will the withdrawal happen? And this is where the idea of SWP makes its mark and the concept of ‘reverse SIP’ kicks in.
SWP requires investors to redeem a certain number of units (based on a precise withdrawal figure) at pre-determined intervals. A monthly regime is quite popular with most individuals; however, quarterly options are also available. For the ideal candidate, this is about discipline, perfectly synchronised in keeping with his financial objectives. The process of withdrawal, quite naturally, leads to the all-important matter being discussed today, “will my principal remain protected while I withdraw my gains?”
What are the most significant points in this context?
- Regular, predictable income – this is often the single most important consideration for retirees
- Made to order – a great deal of customisation can be done as the investor can decide his withdrawal amount and frequency
- Tax edge – depending on several factors, gains from SWP withdrawals may be taxed in a manner that is more efficient compared to interest earned from traditional fixed-income securities.
- SWP may also be viewed in the context of routine and good habits. For the ordinary investor, this can minimise the incidence of unstructured withdrawals.
As investors will no doubt know, each bout of withdrawal will result in the redemption of a certain number of units This is not a fixed number, it will vary every time. Let us assume that the fund in question has done well, and the fund manager has been able to generate high returns. Thus the SWP can function easily on the basis of the gains (that is, notional profit that is yet to be booked). This also means that the principal will not be touched — no harm done to the original investment.
Now imagine it differently. Let us assume that the other situation has materialised and the rate of withdrawal is more than the incremental growth. So with each round of withdrawal, the SWP mechanism will dip into the principal. For the investor concerned, it will not feel quite right. For the average individual, this will look like a stark erosion of capital. It may not be immediately visible, the early months or even quarters may well be relatively easy to bear. Later, however, this will cause a lot of trouble.
Let us take a second step and assume that such a scenario has actually come about. What should the investor do, what measures can be taken? Here is a list of to-dos:
- Consider a temporary suspension of the SWP
- If that is quite impractical to follow, consider a scaling-down of sorts by reducing the amount of regular withdrawal
- Explore the possibility of gradually liquidating other assets, especially fixed-income instruments, instead of depending on SWP altogether
All these will appear as purely temporary solutions. A lot will depend on the market. Is it grossly volatile? Has the fund in question lost ground? Or has it gained sufficiently?
Whatever the scenario, the astute investor will try to remain nimble-footed. He may consider tweaking his withdrawal strategy by extending the frequency of withdrawals. Setting realistic goals at the time of crisis is also vital.
The author is partner at Wishlist Capital (ARN-84929)