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The power of simple ideas

The goal of an SWP redemption is not to improve the average, but to eliminate the worst

The power of simple ideas

SIP is a very simple idea. Basically, instead of investing at one go, just keep investing regularly. If you do that, you will get a better average price because you will avoid investing all your money at high NAVs. That's it.

SWP, the opposite of SIP, is also a simple idea - just as simple. Basically, instead of redeeming at one go, just redeem regularly for a certain period. If you do that, you will get a better average price because you will avoid redeeming your money at low NAVs. That's it.

I didn't have to do any verbal gymnastics to write the two descriptions above as the exact complements of each other. It happened naturally because that's the reality. SIPs and SWPs match perfectly, one for making investments and the other for redeeming investments.

And yet the puzzle is that SIPs are far more popular than SWPs. Over the last decade or so, SIPs have taken over the mutual fund investment landscape. Crores of mutual fund investors use it and if industry investment data is any indication, SIPs do their job very well and are deservedly popular. When markets turn volatile, ad hoc lump-sum investments decline sharply but SIPs go down much less. There are two reasons for this. One, as SIPs continue, investors get proof of their utility. Two, a psychological reason: simply, inertia. In a lump-sum investment, you have to make an effort to invest. In a running SIP, you have to make an effort to stop investing! This makes all the difference.

Logically, SWPs should be just as popular as SIPs. They are certainly just as useful, if not more so. The ultimate goal of investing is to make good returns and then redeem them and use the money. The job is not done till the money is redeemed and back in your bank account and ready to be spent on whatever you want to spend it on. That part of the cycle is done best by using SWPs.

And yet SWPs are relatively unknown. One reason is simply investor awareness. SWPs are known, if at all, as a way of making regular withdrawals from an investment for the purpose of spending regularly - basically, as a way driving regular income. This is an entirely different use of SWPs and a very good one. In most situations, for taxation and other reasons, SWPs are a better way of deriving income from funds than investing in dividend plans and that's something I have written about separately.

However, the cover story in this month's issue of Mutual Fund Insight entirely about a study that our team conducted on the benefits that can be expected from different ways of exiting a long-term SIP investment. We tested a lump-sum redemption as well as SIP+SWP investment methods, whereby one invests for many years through an SIP and then redeems gradually through an SWP. It's a complex study, where we simulated different time periods over many years. The safety effect of withdrawing through SWP is always quite clear.

The most interesting and the most educational part of the results that our team got is that safety and conservatism are an opposing force to the aggressive chasing of returns. Just like SIPs, SWPs do not unequivocally improve your returns. When you do a retrospective study, there are many examples where a lump-sum redemption is better than an SWP redemption! However, the goal of an SWP redemption is not to improve the average, but to eliminate the worst. It's a safety technique, like driving within a speed limit. If you drive fast, you'll often reach your destination quicker but sometimes you may not reach at all. SWP redemption is intended to eliminate that risk.

This is why we have done a detailed study. Look at the results and study the implications. If you like to invest dangerously, go ahead and ignore it.