If you want regular cash-flows from your investments, you may want to choose dividend-paying funds. After all, many mutual fund dividend option schemes have given profitable dividends in the past.
However, no matter how good the fund’s track record is, these dividends are not guaranteed. But you can still get fixed cash-flows regularly from your investments through Systematic Withdrawal Plans (SWPs).
Read this article to learn more about dividends, SWP, and which option is better for you.
Dividend options are now called ‘IDCW’ or ‘Income Distribution cum Capital Withdrawal’. This is only a change in terminology, and does not impact your ongoing investments.
SEBI mandates that dividends have to be paid from the realised accumulated profits, i.e., profits that have been converted into cash. So even if the value of your mutual fund units increases, you might not receive dividends if there are no realised profits.
Additionally, your fund manager may reserve some profit to continue paying dividends in the future if there aren’t any gains. Or, they may choose not to distribute dividends.
Therefore, dividends are not guaranteed. The amount can vary, and so can the frequency.
Additional Read – SWP- Your Solution for Systematic Withdrawal
With an SWP, you can periodically redeem your mutual fund units. You can mandate an SWP similar to an SIP, by deciding the amount and the time interval of withdrawal. Once your mandate has been set up, the amount will automatically be debited to your bank account.
Let us understand this with an example. Suppose you invested Rs. 1 lakh in a fund in August 2021. At the time of purchase, the NAV of each fund unit was Rs. 100, so you purchased 1,000 units. Then, you start a SWP where you want to withdraw Rs. 10,000 every month, for the next four months.
Now, to generate Rs. 10.000, your fund house will redeem a certain number of units, depending on the current NAV. So, your withdrawals will be as follows:
|Month||Amount withdrawn (SWP amount)||NAV||Units redeemed (SWP amount/NAV)||Units remaining||Investment value (Remaining units*NAV)|
So, by the end of December, you have withdrawn Rs. 40,000 and have Rs. 65, 296 invested in the fund.
As you can infer from the table, your unit balance reduces with each SWP instalment. But, if the NAV rises faster than your withdrawal rate, you can continue your SWP and still see appreciation in your remaining units.
Which one should you choose?
Unlike dividends, SWPs are guaranteed, and you know the amount you will receive. So, for a regular source of secondary income, choose SWP.
Remember to keep your withdrawal rate lower than the average long-term return of the scheme. It is best to consult with your financial advisor to plan your SWP according to your financial needs.
Additional Read – Best Investment Ideas to generate Passive Income
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