Are seg funds worth the premium?

Bruce Sellery says you need to do a full cost-benefit analysis before you insure your investments.

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Question

My wife and I have $180,000 in an RRSP at our bank and another $175,000 in an RRSP with an insurance company. The RRSP with our insurance company is in some kind of investment that is guaranteed not to lose our money. It holds a basket of 10 mutual funds with MERs ranging from 2.5% to 3.99% and all of them carry back-end loads/deferred sales charges. But this investment has not made a dime in years. We are 54-years-young and would like to see some positive growth. Any suggestions?

Answer

Buying insurance can be tough. You absolutely must have it on your car to be allowed on the road. You really should have it on your life, if you have a family. But does it really make sense to get insurance on your investments? Insurance comes at a cost and you have to decide it’s worth the price.

I have been thinking a lot about the cost-benefit equation on insurance recently. In fact, I reached out to my insurance broker just last week to ask her to price some additional coverage. She came back with a surprising answer: If I were to change my policy it would lead to a 20% increase in my premium. Ouch. That additional insurance I was looking for was simply not worth the price, in my opinion.

Segregated funds simplified

The product you’re talking about is called a segregated fund and its benefits have been hotly debated over the years. These funds are similar to traditional mutual funds in that they hold a diverse range of securities. There are other differences too, but the most relevant to you is the fact that they are sold by insurance companies and have certain protections built in. For example, your “seg” fund has a “maturity guarantee,” which means that you’ll get a certain percentage of your money back at maturity, regardless of how the market has performed. The fund might also include a guaranteed death benefit or a feature that provides protection from creditors.

But that added protection comes at a cost and you’re paying for it through the higher management expense ratio. That is certainly part of the reason why your fund “has not made a dime in years.” The question is, do you really need that coverage?

Multiple ways to manage risk

A segregated fund is one way to protect you and your wife from the risk of not having enough money in retirement. But there are multiple ways to manage risk—investing more of your portfolio in boring old government bonds, for example. Diversifying your portfolio across regions, sectors and asset classes, perhaps including real estate in the mix are some additional options to consider. You could also choose to work longer if your nest egg isn’t large enough to support your retirement goals. After all, you are both only 54 so you have more time to weather market volatility than you would if you were 20 years older.

One thing people often forget is that you don’t need access to all of your retirement savings the day you stop drawing a paycheque. You need income to help you buy groceries, but that could come from bond income, or from selling a bond mutual fund or ETF. The point is, you shouldn’t have to cash in a mutual fund while its value is depressed because you have other assets to rely on while you wait for the stock market to rebound.

Finding a great financial adviser

You currently have almost $400,000 saved up between your two RRSPs so you shouldn’t have a hard a time finding a fee-based financial adviser to take you on. There are two reasons why I think you should get some expert assistance on this.

The first is that you’ll benefit from someone who can help you get out of the segregated fund. There will be some math involved to calculate how and when to sell at the lowest cost to you. That’s because there may be a penalty for early withdrawal, plus you may have to pay the back-end load (also called a deferred sales charge) and you won’t qualify for the guarantee because you aren’t keeping your money in the fund until maturity. A great financial adviser will factor in all these variables and tell you whether to bite the bullet and sell now, or hold on for a few more years to avoid the penalty and back-end load.

The second reason why I think you should consider paying for an adviser is that you need to create an overall investment plan. This involves stepping back and looking at your goals across a broad range of areas—home, travel, career, family and of course retirement. Then you need to develop an investment strategy that will help you achieve those goals. Per my comments above, this would include an assessment of your tolerance for risk, both in financial terms and in emotional terms, and a plan to manage it. You could do this work by yourself of course, but you may not have the time or inclination.

You are right to question if a segregated fund is a good fit for you—or if the price of this type of insurance protection is simply too much to pay.

ask@moneysense.ca

12 comments on “Are seg funds worth the premium?

  1. I have owned SEG funds for over 20 years the return is average but the security is good. Basically, only put a small amount is into SEG funds

    Reply

  2. My parents have owned segregated funds for approx. 15 years. When reviewing my parents investment statements i noticed that their guareenteed value on my dads statement was approx. the same as the current value, and the guareenteed value was coming due next year. See guareentees are set every 10 years that means for the last 10 years my dad made almost nothing !. He has approx. $155,000 but 10 years ago it was approx. $ 149,000. Even if my dads account was the same as it was at its peak, his gains are piddly. Funnily enough around 2005, I had my mom invest approx. $5000 in some TD mutuals funds, that are now worth approx $8000. She made more on $5000 in about 7-9 years that my dad did on $149000 in 10 years !!!

    My parents would have greater gains if they stuck with GIC's or even a bank Money Market fund.

    Reply

    • Back in those day any guaranteed instrument is that popular and almost every institution have some kind. Even myself have hold at least two of these instrument. Don't really understand what i am getting into but do know that they do guarantee your principal no matter what happen to the market. There are coming up for maturity for next year also.

      Reply

    • they already have take the funds from my chkecing account but they cant find my information anywhere. It has been 3 weeks now and im still not in the system

      Reply

  3. Seg funds are great for protecting your capital or your nest egg, but people forget the GOAL of investing, which is to have enough to retire on. Protecting your capital doesnt alway achieve that capital.

    People make the mistake of thinking Seg funds protect your capital while having the opprotunity make great gains in the market, but the reality is any gains is eaten my MER's, Ins. fees (Seg funds are insured thats how they make those guareentees) and trailer fees (fees paid every year to the sales person who sold you the funds which are typicall 1% per year).

    If you want to protect your capital stick with GIC's and dont kid yourself with Seg funds.

    Reply

    • These i-bankers have been understating the whole crdeit crisis issue since last summer.The higher mortgage bond weighting in Bill Gross’ portfolio is likely a reflection of the extreme mispricing in those assets rather than an indication of the end of the financial storm. In fact, the housing market is still in the midst of a huge wave of foreclosure which will for sure depress housing prices even further. This will of course adversely affect the US economy substantially. In the next few months we will see the real impact of financial markets’ bad news on main street America.

      Reply

  4. Seg Funds are structured quite similarly to Mutual Funds, however true enough, the MER fees are higher. When considering Seg Funds, you should always find out what the MER fees are prior to investing. There are a few companies out there, which I cannot name due to confidentiality constraints on my end, that have MER fees within almost half a percent of that of their Mutual Fund offerings. In this case, Seg Funds are an attractive offering, as they have the built-in protection without having to pay much higher MER fees than that of a mutual fund portfolio. Shop around and don't automatically disqualify Seg Funds, you'd be presently surprised at what you can find out there. Globeadvisor.com is a great site to compare funds, there are some Seg Funds have have outperformed similarly structured Mutual Funds. Research for yourself and defiitely also consult with an experienced financial advisor to ensure you're on the right track.

    Reply

  5. Bruce,

    You made some great points about fees.

    How about this have you averaged 7% per year each year for 10 years?

    How about a guarantee?

    Desjardins had a 7% guarantee for each year (as a Minimum !) for 10 years.

    They took if off the market last year. For a 55 year old you can't do much better than that.
    I think really you have to look at all seg funds and see if they fit. Some do some don't.
    The one with guarantee returns many have been taken off the market. Why? The word is guarantee. Until one can get high rates of return and keep it even in market downturns there is some merit to some seg funds.

    One idea is to set up a table
    Seg funds vs. Mutual funds vs. EFTs, include fees, taxes, guarantees, probate fees etc.
    Also type of person who may consider it.

    Brian

    Reply

  6. These i-bankers have been understating the whole cridet crisis issue since last summer.The higher mortgage bond weighting in Bill Gross’ portfolio is likely a reflection of the extreme mispricing in those assets rather than an indication of the end of the financial storm. In fact, the housing market is still in the midst of a huge wave of foreclosure which will for sure depress housing prices even further. This will of course adversely affect the US economy substantially. In the next few months we will see the real impact of financial markets’ bad news on main street America.

    Reply

  7. I had ESOP in my old company, since ive stopped working there they said the funds were converted to a segregated fund. Can I sell them, they are paying me 25000 every year and i would just like to have the balance in full at once, is this possible?

    Reply

  8. Great article. The question is for a common layman, how to appreciate the merits of Segregated Fund over others?

    Reply

  9. Thank you for your easy to understand explanation of Seg funds, I so appreciate your input!

    Reply

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