Systematic withdrawal plans have their place, as described in my April 6 column. But several readers responded to point out the potential pitfalls of the (mostly) equity fund SWPs used by Canadian investors.

When combined with leverage (borrowing money to invest), a SWP could be downright dangerous, particularly if you believe that today's overvalued stock markets have only one place to go: south, and before next winter.

Don Pooley, a retired financial planner based in Vancouver, advises that the downside of some SWPs are the reverse of dollar cost averaging (DCA).

"The advantage of DCA is that by putting the same amount into an investment every month you acquire more units when prices are low and fewer when prices are high -- a desirable acquisition process," Mr. Pooley says.

But, if you do the reverse through a SWP -- withdraw the same amount from your investment every month -- you end up in the undesirable situation of having to sell more units when prices are low, and fewer when prices are high.

In a prolonged downturn, this will quickly exhaust your investment, Mr. Pooley notes, adding that the next correction is expected by many people "momentarily."

"Unfortunately, many fund agents promote this level withdrawal SWP on very volatile funds without thinking it through," he says. "When I explained it to one, he said he didn't let his clients withdraw more than the fund's average growth rate, which reminded me of the actuary who drowned in a river with an average depth of only 14 inches."

The real danger is if you've financed a SWP by tapping into the equity of your home. Vancouver-based investment advisor Hans Merkelbach says a 30% or 40% drop in the markets would "wipe out retirees' home equity and leave them with a staggering loan obligation at the friendly bank."

Mutual funds consumer advocate Joe Killoran has long used the term "potential SWooP bomb" to describe home equity-leveraged SWPs sold to investors (especially seniors, retirees, and pensioners) to whom the risk/reward ratio may not be appropriate.

Mr. Killoran warns yield-hungry retirees or pensioners not to allow fund salespeople to bamboozle them with presentations of future possible SWP returns based on now-past performance data. Or, to use Mr. Killoran's always colourful language: "Anyone can be a hindsight doctor picking examples of mutual fund leveraged scenarios that have reaped substantial returns -- especially during the last seven to 10 year bull market run. . . But when the next minus 43% thunderbolt correction lingers, eating 26 months of mutual fund SWP redemptions to service the monthly home-equity-loan interest, plus principal repayments, plus taxes owing on the annual fund distributions, the criminally devastating LIFO [last in, first out] margin calls will show their uncaring ugliness in the form of 'we didn't understand' foreclosure signs on the lawns of leverage-abused seniors."

Two readers suggested the 8% withdrawal rate mentioned in the last column may be a tad optimistic. Bylo Selhi, the pseudonym of a regular contributor to the Fund Library's Internet-based discussion forum, says the 8% to 10% rates suggested by some fund companies "are simply not sustainable under adverse conditions like 1970s-style inflation, or the bear markets of 1973 or 1929. Most credible studies (e.g. Moshe Milevsky, Trinity, Harvard, et al) have found that 4% is about the most one can withdraw to ensure that your nest egg doesn't run out before you (and your spouse) do. Especially now that people live longer (20, 30, or more years into retirement) the 8% that many 'experts' promote could prove problematic."

Mr. Selhi also has a bibliography of resources on safe withdrawal rates on the Internet at http://www.bylo.org/saferetr.html.

Dan Hallett, analyst at FundMonitor.com Corp., back-tested monthly returns produced by the Toronto Stock Exchange 300 composite index from February, 1956 through February, 1999. Assuming an average annual inflation rate of 3.5%, he discovered that a $100,000 initial investment and a SWP starting at 5% of beginning value ($416.67 monthly in first year) increasing each year with inflation has so far been sustainable.

The withdrawal rate as a percentage of market value reached a peak of 10.4% in 1977,a low of 3.8% in 1998 and averaged 6.1% over the entire period.

By comparison, the TSE 300 returned just under 10% on average per year over the same period. Raising the SWP's beginning withdrawal rate to 5.5% of beginning market value ($458.33 monthly in first year) and increasing it each year by the 3.5% inflation resulted in a full depletion of capital in 40 years and three months (by May, 1996). This period saw average annual returns of 9.6% for the TSE 300. An 8% annual withdrawal rate lasted just over 17 years during a period that saw the TSE average 8.3% per year.

That analysis uses the consumer price index (CPI), but there have been times when the TSE change is negative and the CPI is high, which could be hazardous for withdrawals. Using TSE and CPI historical data, Mr. Pooley calculates the results of starting with $100,000 in 1956, adjusting it at each year-end for the change in the TSE and inflation. He found 1974 to be a nasty year, dropping by over $50,000 because of 12.3% inflation and a 26% drop in the TSE. The years 1990 to 1994 were also devastating, totally wiping out the $131,380 available at the start of this short period.

On the tax side, Mr. Hallett warns reinvesting all distributions and doing a SWP can lead to an added tax hit. "Consider an income fund which pays monthly income. If all income is reinvested and an SWP is taken, you pay tax on the distribution in addition to the [assumed] gains on each monthly sale of fund units."

Taking the income in cash [and topping it up with a small SWP if needed] provides the desired income stream in a more tax efficient manner, Mr. Hallett says.

"If it's an equity fund that simply pays once annually, you can keep tabs on the expected distribution and skip the last SWP [assuming a capital gain will result]."

A leveraged SWP strategy will also have adverse tax consequences, aside from the investment pitfalls. With each SWP, a portion of the loan interest becomes non-deductible, since Revenue Canada does not consider such loan downpayments to be using the money for income-producing purposes, Mr. Hallet says.

"If, however, you designate distributions to be paid in cash, that money can be used to further reduce the loan. In this case, no adverse tax consequences occur, since no units or securities are actually sold."

The Fund Library (on the Internet at www.fundlib.com) advises that while the site does not yet have editorial content on SWPs, due to the small number of users, its portfolio tracker tool contains a transaction history option for recurring transactions. It allows investors to pre-set automatic buys or sells (withdrawals) for specified funds in frequencies ranging from weekly to quarterly.

Finally, another book which devotes at least a chapter to SWPs is Grant Sylvester's The Money Gap (Toronto: Money Jar Publishing, 1997.)