Should risk-averse investors consider seg funds?
Dave Otto - Aug 12, 2021
When markets are volatile and head south, many investors climb the proverbial wall of worry. Some abandon the markets and head for the safety of cash and cash equivalents. Others remain invested, but ride out volatile conditions in anxiety. Can those who are invested in segregated funds sleep better at night?
The built-in protection against losses as one of the key benefits of seg funds. This is an attractive feature for investors who want growth as well as downside protection on their investments.
Such protection comes in the form of maturity guarantees provided by seg funds. Normally, guarantees are for 75- to 100-per-cent payout of the principal sum invested at maturity or death. The maturity period, which may be linked to the level of the payout, usually ranges from 10 to 15 years. The cost of the guarantee typically rises along with the payout.
This year’s market roller coaster has been a stark reminder for many investors that stocks don’t go up forever. For clients who have been reminded of their aversion to risk, seg funds are worth considering.
During the recent bull market, many investors who chose to invest aggressively in lower fee products like mutual funds and [exchange-traded funds] when the markets were rising felt the pain of the stock market decline.
In contrast, investors in seg funds, which have similar investment objectives, management and return profiles as mutual funds, were left relatively unscathed.
In addition to the benefits of downside protection, higher values can be locked into seg funds during the lifetime of the insurance contract. That’s because the funds have a feature that resets the maturity guaranteed value of the insurance contract on each anniversary date, or less frequently depending on the specific product. The maturity date of the contract may also reset at the same time.
The guarantees are why segregated funds stand out from other investments like mutual funds and equity securities,. Investors in [seg funds] can afford to ride out the ups and downs of the market, knowing that they have downside protection as well as the potential to lock in gains when the markets are rising.
One of the major benefits of seg funds is the downside protection offered by reducing the effect of sequence risk, or the timing of withdrawals from a retirement or similar account.
If you happen to commence withdrawals from your retirement account when the markets are down, then you will be withdrawing money from an account whose value has declined.
As such, investors could run out of money earlier than anticipated because withdrawals are based on the lower account value. Plus, the returns on the amount of money that remains invested while withdrawing funds will be lower. Investing in seg funds that have guaranteed contract values, in some cases, reduces the impact of sequence risk.
Some advisors don’t worry as much about downside protection saying markets historically have always recovered from market crashes. That's of no value for the client who dies at the bottom of a market crash leaving their loved ones will substantially less than they could had with a seg fund guarantee.
If GIC's, homes and autos have built-in fees for downside protection why should not mutual funds?
Still, it comes down to the personal goals of investors, which might simply be based on having a pool of money in an investment they do not have to worry about losing.
But there's more to consider.
Resets to “lock in” your market gains
Segregated fund policies also offer you the ability to “lock in” your gains as part of the principal when you reach a maturity or death guarantee, for an additional fee. If your principle investment grows, then you could lock in at the new total, making this your new guaranteed amount.
This means that, if you pass away or hold onto the fund until it reaches the maturity guarantee, you or your beneficiaries get the new total instead of the original amount.
As for estate planning, all segregated funds allow your beneficiaries to receive your money without having those funds flow through your estate. That means the money in your policy won’t be reduced by taxes and the fees associated with settling an estate. It also means your beneficiaries will get the money faster, since segregated funds policies are usually paid out to beneficiaries within a few weeks of the paperwork being filed.
In comparison, you can also arrange to have your registered mutual funds savings passed on to your beneficiaries when you die. If your beneficiary is your spouse, those savings will be transferred to them quickly, though other types of beneficiaries – such as friends or charities – may have to wait longer. 1
Creditor and liability protection
One difference between mutual funds and segregated fund policies is that the latter offer the potential for creditor and liability protections. That means your assets within a segregated fund policy, whether registered or non-registered, may be protected from creditors, where a specific type of beneficiary – like a spouse or a child – has been named. It also means that, in the event of your death, your assets may be passed onto your beneficiaries without being exposed to creditors. 2
In addition, with segregated funds policies, you may be less exposed to liabilities that could decrease your assets. With the liability protection available in a segregated fund policy, your assets in a segregated fund policy may be protected in the event a lawsuit is filed against you. Together, potential creditor and liability protection could make segregated fund policies an excellent choice for business owners. 3
All considered, seg funds offer significantly more value than mutual funds. Seg funds give you another choice. If your current advisor has not discussed the value of seg funds with you perhaps its time to consider their value.
As Warren Buffett once said, "Price is what you pay. Value is what you get." If you and your loved ones cannot visualize the value seg funds offer at the worst possible time then don't pay the price for them. In order to make that decision you need to be educated on what seg funds are.
Did you know about seg funds before you read this article? If not and want to learn more connect with us today.
1 That said, should you choose a registered mutual fund or segregated fund policy, as opposed to a non-registered one, you can pass funds on to your named beneficiaries without having them go through your estate.
2 Mutual funds in an RRSP may have certain protections in some provinces. Speak with a financial security advisor to learn more.
3 Creditor protection depends on court decisions and applicable legislation, which can be subject to change and can vary from each province; as such, it can never be guaranteed. You should talk to your lawyer to find out more about the potential for creditor protection in your specific situation.