We regularly come across the terms Systematic Investment Plan (SIP) and Systematic Withdrawal Plan (SWP). Organized and purposeful, SIP is a mutual fund investment facility, whereas SWP is a mutual fund withdrawal facility. Individuals might choose between the two approaches depending on their financial goals. In a nutshell, SIP and SWP are systematic approaches to transacting in mutual funds. 

Let us understand each plan individually.

Systematic Investment Plan

We all have regular financial commitments that need a cash outflow for which money may be effortlessly accumulated. Long-term objectives, such as retirement or house ownership, require us to save and invest for many years. Regardless of the amount involved or the time horizon, systematic and regular planning and investing allows you to sail through these commitments. This is where an SIP comes in. 

An SIP is a way of regularly investing small sums of money in mutual fund schemes to create a corpus over time. It can assist a person in making goal-oriented investments. Good planning could be ensured when a person starts an SIP for each objective. An investor might start an SIP with a sum as little as Rs. 500 for convenience; however, this may vary across fund houses. Furthermore, SIPs may be started for different frequencies, such as quarterly, monthly, weekly, or daily, depending on the investor's preference.

Why should one opt for an SIP?

A sound saving habit is developed in investors through an SIP, as well as the compounding effect assists in wealth accumulation. For example, an investment of Rs. 5,000 per month made consistently over ten years at an investment return of 12% (hypothetical figure) per annum can result in a wealth accumulation of Rs. 11.50 lakhs. 

When the market is low, the investor acquires more units of the chosen mutual fund through SIP investing; when the market is high, the investor acquires fewer units. The average cost of the purchase over time can turn out to be lower as a fixed amount is invested periodically. This is known as rupee cost averaging.

An SIP keeps investors from allocating all their funds at a market high, thereby increasing the probability of earning profits. Investing regularly through SIP helps investors take advantage of market volatility and eliminates the need to time the market. On the other hand, in lump sum investing, the entry point becomes important because one may have to book losses if the market falls soon after they invest.

Systematic Withdrawal Plan

You make your investments in a mutual fund through SIP, but when you want to withdraw funds, a Systematic Withdrawal Plan (SWP) could be a way. An SWP is the other side of the same coin as it works in an opposite way as compared to Systematic Investment Plan (SIP). In an SIP, you channel your bank account savings into the preferred mutual fund scheme. Whereas in an SWP, you direct your investments from your mutual fund to your bank account.

The investor can select a day of the month/quarter/year for withdrawal and the money will be credited to his/her bank account by the Asset Management Company (AMC). The investors may also choose to either withdraw just the capital gains on their investment or a fixed amount. SWP is ideal for investors looking to receive regular cashflow.

How does an SWP work?

When you start an SWP, it has an impact on your mutual fund account. In a Systematic Withdrawal Plan, the amount/ units you withdraw is reduced from the amount / units held in your portfolio.

Suppose you own 10000 units in a mutual fund scheme, and you wish to withdraw Rs. 3000 every month through an SWP. Imagine the scheme's net asset value (NAV) to be Rs.10. The withdrawal of Rs. 3,000 from this scheme will mean that 300 units are being sold, which is Rs. 3,000/NAV of Rs.10. After this withdrawal, the remaining units in your mutual fund will be 9,700 (10000 - 300).

At the beginning of the next month, if the NAV of your scheme increases to Rs.20, then the withdrawal of Rs.3,000 would mean selling 150 units, which is Rs 3,000/NAV of Rs 20. Your holdings in the mutual fund would be left as 9,550 units post this withdrawal (9,700 - 150). As a result, the units you hold will decrease with each withdrawal.

This means at higher NAVs; you may be able to redeem fewer units to meet the cash requirements. If the NAV declines, the reverse consequence occurs, necessitating the redemption of more units. If you make unanticipated withdrawals, it might harm the value of your fund. Planning the SWP with your requirements and ultimate goal in mind is critical to benefiting from and making the most of this strategy.

Why should one opt for an SWP?

SWP in mutual funds provides regular cash flow to investors for regular expenses. Investors may also withdraw their money, which is effectively redemption, without being subjected to tax deductions at source (TDS). The withdrawals, however, are subject to exit load, if any, and capital gains taxation.

SIP vs SWP – The Verdict

SIP and SWP are mutual fund vehicles with different objectives. SIP helps you invest, while SWP delivers regular cashflow. SIP is perfect for beginners wanting to begin an investment habit. Conversely, SWP is for experienced investors who have accumulated wealth over the years and now want to increase their cash inflow, especially after retirement. Investors can either employ the investing and withdrawal strategy or the twin strategy.

Let’s say you invest Rs. 5,000 every month in SIPs of a mutual fund scheme for ten years. If the rate of return is assumed to be 10% per annum (hypothetical figure), you would have accumulated a corpus of approximately Rs. 10 lakhs after ten years. After ten years, you plan to opt for SWP from the same scheme, wherein, hypothetically, the corpus continues to grow at 10% per annum. You decide to withdraw Rs. 10,000 per month from your corpus. In one year, you would have withdrawn Rs. 1.2 lakhs and your wealth should have decreased to Rs. 8.8 lakhs. But due to the power of compounding, the corpus amount after a year will increase to approximately Rs. 9.74 lakhs.

The strategy helps you reach your short-term and long-term financial goals, such as paying off loans, funding your children’s education and handling financial emergencies.

To conclude, we may say both SIP and SWP are excellent strategies for investment planning and financial success. Your financial goals are achieved by investing wisely, and SWP and SIP provide financial success in different ways, including rupee cost averaging, compounding, shielding from market timing, and so on. SWP and SIP have different purposes. SIP uses investments to achieve your investment objectives, whereas SWP gives you regular cashflow. By integrating the two, you receive optimal results while receiving regular cash flows. Before investing in either of the avenues, do your due diligence to ensure you've properly evaluated the investment options. You may choose any investment avenue that meets your investment goal, whether SIP or SWP.

Mutual fund investments are subject to market risks, read all scheme related documents carefully. The information in this document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipients of this material should rely on their investigations and take their own professional advice.