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  • Loan Against Mutual Funds vs. Systematic Withdrawal Plan

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  • Category: Finance
  • Published Date: June 7, 2024
  • Modified Date: June 7, 2024
  • Reading Time: 5 Minutes

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When faced with financial needs, investors often look for the most efficient ways to access liquidity from their investments. Two popular options for mutual fund investors are taking a loan against mutual funds (LAMF) and opting for a systematic withdrawal plan (SWP). Every strategy has its benefits and drawbacks. This article explores the differences between these two approaches, helping investors make informed decisions based on their specific financial situations.

Understanding Loan Against Mutual Funds

A loan against mutual funds allows investors to pledge their mutual fund units as collateral to secure a loan from a bank or financial institution. This option provides immediate liquidity without requiring the sale of mutual fund units, allowing investors to maintain their investment and continue benefiting from potential market gains. The process involves the following steps:

  • Eligibility and Application: Investors must hold mutual funds in demat form and meet the lender’s eligibility criteria. The application process involves submitting necessary documents and pledging the mutual fund units.
  • Loan Amount: The loan amount is typically a percentage of the mutual fund’s net asset value (NAV), usually ranging from 50% to 80%.
  • Interest Rates and Tenure: Interest rates on LAMF are generally lower than those on personal loans, making it a cost-effective borrowing option. The loan tenure can vary from a few months to several years, depending on the lender’s terms.

Advantages of Loan Against Mutual Funds

  • Liquidity without Selling Investments: LAMF provides immediate funds without selling mutual fund units, allowing investors to retain ownership and benefit from future appreciation.
  • Lower Interest Rates: Interest rates on LAMF are typically lower than those on unsecured loans, reducing the overall borrowing cost.
  • Flexibility in Repayment: Investors can choose flexible repayment options, including paying only the interest during the loan tenure and repaying the principal at the end.
  • Tax Benefits: Interest paid on LAMF may be tax-deductible under certain conditions, providing potential tax savings.

Disadvantages of Loan Against Mutual Funds

  • Risk of Market Fluctuations: If the market value of the mutual fund units falls, the lender may ask for additional collateral or partial repayment to maintain the loan-to-value ratio.
  • Impact on Returns: The loan interest must be factored into the overall returns, potentially reducing the net gains from the investment.
  • Limited Loan Amount: The loan amount is restricted to a percentage of the mutual fund’s NAV, which may not meet significant financial needs.

Understanding Systematic Withdrawal Plan

A systematic withdrawal plan (SWP) allows investors to withdraw a fixed amount from their mutual fund investment at regular intervals, such as monthly, quarterly, or annually. SWP is an ideal option for those who need a steady income stream or wish to gradually liquidate their investment without redeeming all units at once. The process involves:

  • Setting Up the SWP: Investors select the mutual fund scheme and specify the withdrawal amount and frequency. The plan is then set up with the mutual fund house.
  • Regular Withdrawals: The specified amount is withdrawn at the chosen intervals, with the corresponding number of mutual fund units redeemed based on the prevailing NAV.

Advantages of Systematic Withdrawal Plan

  • Steady Income Stream: SWP provides a regular income stream, making it suitable for retirees or individuals needing consistent cash flow.
  • Flexibility: Investors can modify the withdrawal amount and frequency as needed, providing flexibility to meet changing financial needs.
  • Capital Gains Management: By spreading withdrawals over time, investors can potentially manage capital gains tax liability more efficiently.
  • Continued Investment Growth: The remaining invested units continue to grow, allowing for potential capital appreciation.

Disadvantages of Systematic Withdrawal Plan

  • Impact on Investment Corpus: Regular withdrawals reduce the investment corpus, potentially affecting long-term growth if the withdrawals exceed the returns generated.
  • Market Risk: Withdrawals during market downturns may lead to selling units at lower NAVs, impacting the overall returns.
  • Potential Tax Liability: Withdrawals are subject to capital gains tax, which may affect the net income received.

Comparing Loan Against Mutual Funds and Systematic Withdrawal Plan

  • Purpose and Usage: LAMF is suitable for short-term liquidity needs without liquidating investments, whereas SWP is ideal for generating a steady income stream.
  • Impact on Investment: LAMF allows investors to retain ownership of mutual fund units, while SWP reduces the investment corpus through regular withdrawals.
  • Cost of Funds: LAMF involves interest payments, potentially reducing net returns, whereas SWP may incur capital gains tax on withdrawals.
  • Flexibility and Control: Both options offer flexibility; LAMF in terms of repayment and SWP in terms of withdrawal amounts and frequency.
  • Risk Management: LAMF carries the risk of market fluctuations affecting collateral value, while SWP carries the risk of withdrawing during market downturns.

Choosing the Right Option

The choice between LAMF and SWP depends on individual financial goals and circumstances. Investors seeking short-term funds without disrupting their investments may prefer LAMF. However, those requiring a regular income stream for expenses or retirement may find SWP more suitable. It’s essential to evaluate the cost implications, tax considerations, and market conditions before making a decision.

Conclusion

Both loan against mutual funds and systematic withdrawal plans offer valuable solutions for accessing liquidity from mutual fund investments. By understanding the unique features, advantages, and disadvantages of each option, investors can make informed choices that align with their financial goals and risk tolerance.

Whether opting for the immediate liquidity of a loan or the steady income of a systematic withdrawal plan, careful planning and consideration are crucial to maximizing the benefits of mutual fund investments.

By Sanju Biswas
who is a freelance writer based out of Delhi, MA. He writes most often on health and education. When not writing, He enjoys reading and watching film.

Member since June, 2024
View all the articles of Sanju Biswas.

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