Turn Mutual Funds Into Monthly Income (Part 3 - Key SWP Decisions)

Before we dive deeper into the SWP decisions, here are the links to Part 1 and Part 2 of the series, which cover the concepts of IDCW and basics of SWP.

Part 1: Turn Mutual Funds Into Monthly Income (Part 1 - Stocks Give Dividends, Mutual Funds Have IDCW)

Part 2: Turn Mutual Funds Into Monthly Income (Part 2 - Systematic Withdrawal Plans - Reverse SIPs)

Where should the portfolio/corpus be invested before commencing SWP?

Given the longer time horizon with SWPs, financial advisors typically recommend multi-asset funds, hybrid funds or balanced advantage funds, since these funds allow for dynamic allocation across various asset classes. Of course, the final selection depends on a lot of things, like the risk profile of the investor, goals, earnings, living expenses, duration of the investment and so on.

Hybrid category is most suitable for SWP however individuals who do not want equity risk can also evaluate corporate bond funds for SWP.

Do check out Creso - Powering India's Next-Gen Mutual Fund Distributors for a list of mutual fund schemes under the above-mentioned categories.

What should my withdrawal amount be?

Two key variables drive the success of an SWP plan – the corpus or investment value as of the SWP start date (we will call this ‘initial corpus’ for simplicity) and the monthly withdrawal amount (for the sake of simplicity, we would assume monthly withdrawals going forward, but investors have the option to select other frequencies as well).

Both need to be balanced appropriately – a higher monthly withdrawal amount on a smaller initial corpus could result in corpus depleting before the planned/anticipated tenure, impacting the goals and cash flows of the investor. Conversely, a lower monthly withdrawal on a large corpus could mean the investor is not fully utilizing the lifestyle his corpus can support.

Typically, a higher investment value can enable higher monthly SWP payouts and also extend the duration of SWP thereby providing cushion to investors

Let’s look at this with the help of an example:

We have created scenarios based on investment value of ₹ 1cr, 3cr and 5cr with 10% return CAGR over 20-year timeframe. The table below illustrates the value of the portfolio at the end of 20 years assuming varying monthly SWP amounts.

Portfolio value after 20 years (₹ in crores):

If the investor starts a monthly SWP of ₹1 lakh with an initial corpus of ₹ 1cr, the corpus will get over before the intended 20-year duration. This poses a significant risk to the investor and necessitates a re-evaluation of their financial plan.

Please note that we have not assumed inflation in the expenditure profile of the investor and kept the monthly SWP amount constant over the 20-year duration.

Let us inflate the monthly SWP amount by 6% annually over the 20-year timeframe to factor the annual increase in expenses (assuming the same 10% annual return). The portfolio value at the end of 20 years works out to just ~₹ 1.3cr using an initial investment of ₹ 1cr and monthly SWP of Rs. 50,000 with 6% annual hike in payouts.

Portfolio value after 20 years (₹ in crores):

How do portfolios shape up under varying return scenarios?

The return expectation of an investor is anchored on numerous factors and financial advisors help to assess risk-return through detailed financial profiling of investors.

Since monthly SWP payouts are essential for retirees and individual seeking steady income, we intend to highlight how varying rates of return can impact SWP duration and portfolio value at the end of the SWP duration. This will help investors and financial advisors select an appropriate risk-return profile for their proposed investments, based on their corpus and withdrawal requirements.

Let us understand this further with an example

Portfolio value after 20 years (₹ in crores) - Assuming initial corpus of ₹1 cr and 20-year SWP duration:

Portfolio value after 20 years (₹ in crores) - Assuming initial corpus of ₹3 cr and 20-year SWP duration:

An initial corpus of ₹1 cr combined with a monthly SWP payout of ₹1 lakh may result in corpus getting completed depleted before the end of 20-year duration if the rate of return is sub-10%.

Now let us get inflation into the above scenarios and the situation becomes even more tricky.

Portfolio value after 20 years (₹ in crores) - Assuming initial corpus of ₹1 cr + 20-year SWP duration + 6% inflation:

Portfolio value after 20 years (₹ in crores) - Assuming initial corpus of ₹3cr + 20-year SWP duration + 6% inflation:

Inflation-adjusted SWP payouts result in lower portfolio outcomes but are more in sync with economic realities.

Key takeaways:

• Larger initial corpus provides flexibility in SWP payout as well as duration

• Annual withdrawal rates of 3-5% provide comfort during volatile market environment

• Slightly conservative return expectations provide cushion to the overall investment plan

Please note that we have not changed the SWP duration in any of the above examples since it is an investor specific requirement. We have assumed that SWP starts at age 60 and assume an average life expectancy of age 80. However, different circumstances like early retirement, layoffs, etc may create the need for an SWP early in life and for an extended time duration

Key Disclaimer: Please consult with your financial advisors to get recommendation specific to your financial needs. All the examples mentioned in this blog are purely illustrative and maybe rounded off, wherever required.