Understanding the cost of segregated funds


Many investors, especially those facing retirement, are often offered so-called “segregated” funds by their financial advisors as a way to participate in the stock market while guaranteeing their principal. While a segregated fund might hold a portfolio identical to its non-segregated counterpart, its fees are typically much higher, while returns tend to be lower. Does it make sense to invest in seg funds?

A mutual fund is basically a pool of money contributed by investors, each of whom holds units in the fund commensurate with the amount invested. The fund then invests the money in securities that may include stocks, bonds, and money market instruments. Mutual funds are regulated by provincial securities regulators and provide no guarantees of investment performance. They are best suited to people who want broad diversification in their investment portfolio. When you invest in mutual funds, you are willing to give up guarantees in return for potential of increased returns. The average Management Expense Ratio (MER) of a mutual funds is about 2%.

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Segregated (“seg”) funds, on the other hand, are insurance products and are regulated by provincial life insurance legislation. Your premiums (net of fees) are invested in the segregated funds of an insurer, which, in turn, invests the money in such securities as stocks, bonds, and money market investments. Insurance companies often team up with mutual fund companies to provide a “branded” seg fund whose investments are identical to an existing mutual fund.

The twist is that the seg fund version provides a principal guarantee, typically between 75% and 100% of your principal at the end of a specific period of time, usually 10 years or at death. Seg funds also provide protection from creditors and avoid probate (because of their characteristics as an insurance policy), while mutual funds do not. Average MER for seg funds is much higher than for mutual funds, ranging between 2.5% and 6%, in order to pay for that insurance coverage.

While seg funds are more expensive than mutual funds, they do offer certain advantages over mutual funds – the principal guarantee, creditor protection, and probate avoidance mentioned above. The choice of investment vehicle really depends on your tolerance for risk. I recommend you speak to your investment advisor to determine if the seg fund guarantee is worth the offset in lower return.

If you are close to retirement, are concerned about market volatility, and are looking for guarantee of principal then perhaps some seg fund allocation might work for you. On the other hand if you are a between 35 and 50 and have a moderate risk tolerance, you might want to consider lower-cost mutual funds or exchange-traded funds (ETFs).

Courtesy Fundata Canada Inc. © 2016. Robyn Thompson, CFP, CIM, FCSI, is president of Castlemark Wealth Management. This article is not intended as personalized advice. Securities mentioned are not guaranteed and carry risk of loss. No promise of performance is made or implied.

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