There are two routes to withdrawing amounts from your mutual fund investments for your cash flow requirements, which are distinct from exiting the schemes. The two modes available are the dividend option and SWP (systematic withdrawal plan). The other way of withdrawal is in the form of a lump-sum, as and when required, which is ad-hoc. Let’s first understand the concepts of dividend and SWP.
Taking out money
Dividends are distributed from the surplus accumulated in the dividend option of a fund, from time to time. The quantum and timing of the pay-out are at the discretion of the fund manager. There are certain defined dividend options – monthly, quarterly etc. – and AMCs do pay out in that frequency on a best-effort basis, though there is no obligation to do so. In other words, if a fund pays a dividend after one year in the quarterly dividend option, it would not be violating any rule. The reason: dividend distribution is subject to availability of a 'distributable' surplus in the fund, which in turn is a function of the underlying market. To overcome this issue, sometimes, fund managers keep some ‘reserve’ in the NAV – i.e., they pay-out an amount that is less than the available surplus – to provide for future dividend pay-outs during adverse market conditions. If you try to gauge the future dividend pay-out of a particular fund from the pay-out history, it would at best be indicative.
An SWP is a method of withdrawing a defined amount, at a defined frequency, so that the money comes to you from your investment. If the amount withdrawn periodically is on the lower side, within the earnings accruing to the fund, it is fine. If the quantum or frequency of withdrawal is on the higher side, it will draw from your principal. However, you need not fret over withdrawing from the principal, because it is your money, meant to be used by you. An SWP is the best mode of withdrawal for retired people, as the desired quantum of money flows from the investment kitty. The other advantage of an SWP is tax efficiency. The holding period for eligibility for long-term capital gains taxation is one year for equity funds and three years for debt funds. For tax efficiency, provided your horizon permits, invest in growth option and start the SWP after one year of holding for equity funds and three years for debt funds. Tax is computed on a FIFO (first in first out) basis; hence you will get the benefits.
Choosing the better mode of withdrawal
Now let’s come to the issue we raised; i.e., which withdrawal route is better for you. The answer is the SWP, due to the following reasons:
Limitations of taking the dividend route:
- The quantum of dividend may be on the lower side; less than your requirements
- The frequency may be uncertain; history is only indicative
- The pay-out decision rests with the fund manager, not you
- The dividend option is less tax efficient than the growth option, for debt funds
- Mutual Fund is a route for long-term wealth accumulation, not high pay-outs
Advantages of taking the SWP route:
- You can customize the amount, frequency and duration as per your requirements
- You can start an SWP anytime, to suit your requirement
- You can increase/decrease the amount or even stop the SWP when needed
- Generate tax efficiency in debt funds by starting the SWP after holding for three years
Another relevant aspect in this discussion is positioning of certain funds, particularly balanced schemes, on the basis of regular dividend pay-outs. What we need to understand here is that mutual funds are not Post Office Monthly Income Schemes (MIS). A mutual fund is a vehicle for long-term wealth accumulation from the underlying market, with your preferred allocation between equity and debt. For a section of investors, for e.g., retired persons who may require regular cash flows, SWP is the better mode of withdrawal. Otherwise, the pitch of “1 per cent dividend per month plus market upside” creates an illusion for the not-so-savvy investor of higher returns. If the market is favourable, you will get even better returns in the growth option; the dividends are not anything over-and-above what is due to you.
To conclude, mutual funds invest money, on your behalf, in the underlying market, i.e., equity or debt. Returns from the market will anyway accrue to you. Dividends paid to you are not an ‘extra’ or ‘bonus’ and are to be seen accordingly. The way a Systematic Investment Plan (SIP) lets you invest in a fund as per your cash flow, an SWP lets you withdraw as per your cash flow requirements.
(The writer is founder, wiseinvestor.in)
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