Thursday, April 14, 2016

When You Aren’t Able to Stomach the Ride

When the market value of your investments is falling, do you feel skittish?  Do you question your motives for investing in the markets?  Do you believe you can handle the volatility yet in reality are unable to stomach the turbulences?  You want to earn a higher return than the amount paid on GIC investments but at the same time know you can’t afford or are unwilling to take the risk.  What are other options?

In the previous blog, Investing in the Rise and Fall of the Markets, mutual funds were introduced as an option for participating in the markets.  The notion of combining your investment dollars with others to invest jointly and diversify broadly into different asset classes and sectors of the world’s economy certainly has its appeal but nevertheless still comes with potential market risk.  If you are still feeling skittish, you may be consoled knowing a layer of protection can be added to guard the value of your capital investment.   You must determine if the cost that comes with this protection is worth having in exchange for peace of mind.

A segregated fund policy has all the similarities of a mutual fund with an important exception.  Because these investment products are offered by insurance companies, they include built-in guarantees to protect either 75% or 100% of the capital in the event of an upheaval in the markets at the time of maturity or death. The two values, both the current market value and guaranteed value, are compared to ensure the higher amount is paid.

For example: Let’s assume five years ago you invested $100,000 into a segregated fund policy which offers 75% maturity and 100% death benefit guarantees. Today, the current market value may be $125,000; the maturity value remains at $75,000, and the death benefit is $100,000.  Because of the opportunities in the markets, you are optimistic that your investment will be lucrative but you feel comfortable with the guarantees in case the trend changes.        

Generally, the guarantee is determined on a 10-year holding period.  Some segregated fund policies may allow the option to lock in any market gains. Once you accept the higher value, you reset the market value as well as establish a new guarantee.

Segregated funds have been around forever. Perhaps “forever” may appear as a bit of an exaggeration but more than thirty years can seem like an eternity. In other words, segregated funds are not new.  Most likely, mutual funds may have stolen the limelight from segregated funds because mutual funds’ management expense ratios (MERs) are lower.  The higher MER fee (upwards of 1%) with segregated funds is the cost for the added insurance protection.  If this allows you to feel at ease, then the extra cost may be worth it.  You honestly do not see the fee since this insurance premium is included with the other management expenses associated with the normal operation of the funds.  The total MER costs are subtracted from the rate of return of the investment.

When considering investments options, determining the right strategy for you may require some investigation.    Whether you are choosing GIC investments, mutual funds, or a segregated fund policy, you are looking for the best alternative built with your intentions in mind (not someone else’s.)   

  • If the value of your estate is significant, one consideration may be to bypass the probate process using segregated funds to distribute a portion of its value directly to beneficiaries. 

  •  If you know that inflation is currently at 2.00%, you may not be satisfied with earning an average interest rate of 1.60% in GICs (Guaranteed Investment Certificates) even though these investments offer principal protection. 

  • If you can’t ride the market’s roller coaster and tolerate investment fluctuations, you may desire the guaranteed protection of principal offered by a segregated fund policy.

Endorsing one product over another is only an appropriate strategy if it’s appropriate for you.  Just because one product is right for one person doesn’t necessarily mean it fits the needs of another.  Be informed about the investment options available so you are able to make the best decision for your circumstances.  
To read more about the difference between segregated fund policies versus mutual funds, you may click here to read Canada Life’s brochure, Intelligent Investing Design Your Future or Advocis® publication, Segregated Funds Come with a Guarantee. Other helpful information on segregated funds can be found at Get Smarter About Money.  

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