Much is written about fees. Fees are what you pay for a service you value to address a problem. Usually, to protect yourself against a potential loss at the worst time.
Fees themselves are not the problem. The problem is the problem. Fees are the solution to a problem.
When considering if there is value in paying a fee, take a look at segregated funds. Segregated funds have been likened to “investing with a safety net” and “mutual funds with benefits.”
Before diving in, let’s start with a review of mutual funds and how they differ from segregated funds.
Mutual funds are investment vehicles that many investors have embraced as a simple and relatively inexpensive method for investing in various assets. Over time, they have become one of the most popular investment tools that allow for diversification by following a specific exchange with passive and active management options.
Segregated funds are like mutual funds as they have an investment component. Both vehicles represent a collective pool of investments that individuals put money into, but they possess some key differences.
Differences between mutual funds and segregated funds
- Segregated funds are life insurance products sold by insurance companies, as a result, the governing bodies and regulations responsible for overseeing segregated funds are usually the same ones that cover insurance companies.
- Segregated funds generally offer a degree of protection against investment losses. For example, most segregated funds will guarantee around 75-100% of premiums paid minus withdrawals in the event of maturity or the policy holder’s death.
- Segregated funds also have some other benefits relating to the death benefit portion of their policies since they double as life insurance policies. Beneficiaries of the policy will usually receive the greater of the guarantee death benefit or the market value of the fund holder’s share directly.
- Segregated funds, when a protected beneficiary (spouse, child, grandchild) are named, bypass the time-consuming estate process with funds typically paid out within weeks escaping Estate Administration Tax and, by virtue of legislation, are private and may be protected from claims of creditors.
- On the other hand, with a mutual fund, the market value of the asset is subject to the same estate-related processes that other assets go through, which means it may take some time (months, years in some cases) before any parties receive a payout.
With these bells and whistles, segregated funds fees tend to be higher (on average) than mutual funds.
If investment guarantees are not important, why are GICs automatically insured?
Because investors, as the result of previous losses, want them to be. And to be insured, you pay a fee, and that fee is embedded into the interest rate.
Why do we insure homes, cottages, our expensive toys, and vehicles? Because we worked hard to earn them and want them replaced in the event of losing them.
I find it interesting when I hear someone comment that segregated funds are not worth the extra fee you must pay for them. Let’s dive into this a little.
What fee are you paying to insure your home? Your cottage? Your toys? Your GIC?
To insure a home worth around $600,000 is about $1,400 a year or about 0.2%.
To insure a segregated fund is around 0.2 to 0.4% depending on the risk – lower for fixed income funds and higher for equity funds.
In addition to guaranteeing a floor on death and maturity, the fee also includes the ability to appoint beneficiaries on non-registered plans, privacy of fund distribution details, potential protection from claims of creditors on non-registered funds, no probate and estate administration fees, and expediency of distribution.
This last point is worth noting. Distribution might take a few weeks instead of many months, as is the case with mutual funds. One of my clients had to wait 14 months for their deceased husband’s mutual fund.
Ask a beneficiary who is waiting months and in need of funds, at one of the most stressful times in their lives, during a stock market decline, if they think paying a small fee for a segregated fund was worth it.
The ability to reset the floor to lock in gains and guarantee income for life (Guaranteed Minimum Withdrawal Benefit), even if the fund declines to zero, is also available for an additional fee if desired.
By the way, Guaranteed Investment Certificates (GICs) with an insurance company provide some of the above benefits also — it’s like a “GIC with benefits.”
Those who argue against the extra cost of seg funds say, “if there’s only a 1% chance that stocks will lose that much over ten years, the extra fee you have to pay for a segregated fund may not be worth it.” Following this same argument, if there is only a 1% chance your house will decline in value due to a fire in 10 years, the fee you pay to insure it may not be worth it. Yet, everyone still does.
Further, don’t assume that higher fees means lower performance than mutual funds. It is not uncommon to see seg funds, even with their extra fee, perform better than mutual funds.
The great thing about these vehicles is that consumers have a choice! However, if GIC’s are automatically insured without giving us a choice, and we insure our homes and other assets from potential loss, why not protect one of the largest assets people own?
My point is many mutual fund investors should revisit what they really want.
