Personal Investor: Segregated funds beyond the sales pitch
Do you want an investment that can make money with no risk?
That’s basically the question RBC Insurance asked in a recent survey, and 87 per cent of respondents said yes. Who wouldn’t?
RBC Insurance sells segregated funds and that is how they are sold by some advisors because seg funds are the only single product that can provide upside growth and downside protection.
In fact, under the know-your-client rule an advisor is obligated to put a client that answers yes to that question in a seg fund.
A segregated fund is essentially a mutual fund wrapped in an insurance product. The fund holds investments that can gain in value but up to 100 per cent of the principal is guaranteed.
Seg funds also offer creditor protection in the event of bankruptcy, can bypass probate to get funds to beneficiaries faster and provide a death benefit of up to 100 per cent.
But there is a price to pay for mixing profit and security: higher fees. Survey respondents were not told what those fees are, yet only 33 per cent said they wouldn’t mind paying a higher fee for added protection. Forty-seven per cent said they wouldn’t and 20 per cent were unsure.
Here are a few more facts about segregated funds that many people don’t know.
The principal guarantee applies to a ten-year period. Funds rarely lose money over ten years and risk can be lowered to help ensure they don’t. Of course, you can’t lower risk without limiting upside opportunity.
The annual fee (management expense ratio) can be as high as four per cent, compared with a standard mutual fund MER of about 2.3 per cent. That means if a seg fund produces an annual return of seven per cent, the investor will only see a three per cent gain. On an investment portfolio of $200,000 that’s an annual fee of $8,000. In most cases hefty fees are also imposed when the fund is sold.
Seg fund fees do not need to be disclosed in dollar amounts. New regulations that require advisors to disclose their fees in dollars, called CRM2, do not apply to segregated funds because they are considered insurance products.