The steep ‘peace-of-mind’ premium
Both mutual funds and segregated funds provide investors the opportunity to invest in stocks and bonds managed by a professional money manager. The managers of both mutual funds and segregated funds look to invest the funds contributed by individual investors in a range of investments, depending on the mandate of the fund (e.g, stocks, bonds, or a mixture of both). When you purchase these types of funds, you are pooling your money with other like-minded investors to achieve a desired investment return. The difference between the two types of funds lies in how they are structured. Let’s look at mutual funds first:
A mutual fund is money pooled and invested on behalf of unitholders in securities that may include stocks, bonds, and money market investments. These types of funds are regulated by provincial securities regulators and provide no guarantees on investment performance. Mutual funds are best suited to people who want a wide variety of specialized fund choices in their investment portfolio. When you invest in these types of funds, you are willing to give up guarantees for potential increased returns. In reality, you could lose everything you invest. Average management expense ratio (MER) is between 0.50% and 3.0%.
Segregated funds, on the other hand, are insurance products regulated by Provincial Life Insurance Acts. While they may appear to be mutual funds for all intents and purposes, the money you use to purchase units of a segregated fund is essentially an insurance premium (after fees, or “net of fees”). Your money is invested by the insurer in a pool of securities such as stocks, bonds, and money market investments.
The difference between segregated funds and conventional mutual funds is that seg funds usually provide a guarantee of between 75% and 100% of your principal at the end of a specific period of time, usually 10 years or at death (this is the insurance element of the seg fund). Seg funds also provide protection from creditors while mutual funds do not. Average MER for seg funds is between 2.5% and 6%.
Segregated funds are more expensive then mutual funds but do offer certain advantages over mutual funds. The choice of investment vehicle really depends on your tolerance for risk. I recommend you speak to your investment advisor to determine if you are giving up potential returns by paying a higher MER for the segregated funds or if the higher fee associated is worth the guarantee to you.
If you are close to retirement and are concerned about the current market volatility, then perhaps some exposure to seg funds may be warranted, but consult with your advisor before purchasing segregated funds, as there may be penalties involved if you sell before a seg fund’s maturity date.
© 2014 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited.