Much is being written about fees. As discussed in an earlier article, fees are what you pay for hopefully a service you value to address a problem, usually to protect 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.
One area where this deserves more consideration if there is value in paying a fee is regarding segregated funds, that have been likened to “investing with a safety net” and “mutual funds with benefits”.
Before diving in, let’s start with a review what mutual funds are 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 a variety of assets. Over time, they have become one of the most popular investment tools that allow for diversification by following a specific exchange, with options for both passive and active management.
Meanwhile, segregated funds are like mutual funds as they have an investment component, but they possess some key differences as well.
Both investment vehicles represent a collective pool of investments that investors invest into.
Segregated funds are life insurance products sold by insurance companies and, as a result, the governing bodies, and regulations responsible for overseeing segregated funds are usually the same ones that cover insurance companies.
Second, 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 directly receive the greater of the guarantee death benefit or the market value of the fund holder’s share.
With a mutual fund, on the other hand, 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.
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.
With these bells and whistles, segregated funds, their fees tend to be higher (on average) than mutual funds.
If investment guarantees are not important why are GIC’s automatically insured? Why? 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 loss.
I find it interesting when I hear someone comment that seg funds are not worth the extra fee you must pay for them.” So, lets investigate this a little.
What fee is being paid 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 seg fund is around 0.2 to 0.4% depending on the risk – lower for fixed income funds and higher for equity funds.
The fee, in addition to guaranteeing a floor on death and maturity, 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 (couple weeks vs many months – one client had to wait 14 months for their deceased husbands 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 seg fund was worth it.
The ability to reset the floor to lock in gains, and to guarantee income for life (Guaranteed Minimum Withdrawal Benefit), even if the fund declines to zero, is also available for additional fee, if desired.
By the way, GIC’s with an insurance company provides some of the above benefits also – 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 a 10 year period, 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.
The great thing is consumers have a choice! However, if GIC’s are automatically insured without giving us a choice, and we insure our homes and other asset from potential of loss, why not protect one of the largest assets people own not insured? My point is, there are many mutual fund investors who should revisit what they really want.
Dave Otto B.B.A. CFP®️ CLU®️ CH.F.C.®️ EPCÒ
Founder and President, DO FINANCIAL