Using segregated investments to protect in market downturns

BY: FAZAAD BACCHUS 

During a market downturn, a client can see great fluctuations in their investment portfolio. Last week alone we saw investment portfolios falling as much as 6 %. That’s sixty thousand dollars on a million dollar portfolio. What can a person do, that guarantees their principal if they were to pass away while the market is in a downturn?

Most people at some point in their life are doing some form of investing. Many have been utilizing RRSP’s for a long time now and more recently making use of the TFSA. These investments are more commonly invested in mutual funds purchased at your local bank branch. They provide no guarantee of principal or any guarantee of returns, so it’s possible to lose money if the markets are bad. Over time, and provided that you have a good financial advisor you will most likely recover any losses as the markets generally move in an upward direction. But the operative word here is “over time”.

On the other hand, there is an investment product that runs on a similar basis to mutual funds, the underlying funds are the same, the performance is the same but there are some differences that might be valuable to certain clients. It has proven to be of significant value when there is a downturn in the market as the values are protected. This type of investment is called segregated funds and is only sold by life insurance companies. Depending on the contract that you have entered into, it can pay as much as 100% of your principal invested in the event of the death of the owner.

Let’s take the example of someone who has an RRSP in mutual funds, if the market falls like it did in 2008 and the owner dies, what is payable to the beneficiaries is only the market value. However, if that same person had a segregated fund investment and the market falls, the beneficiaries could receive the full amount invested (or even more based on another feature called resets), regardless of the fact that market value is significantly lower. A segregated fund has protection built into it, where there is a guarantee of principal in the event of death or maturity of the owner.

A segregated fund is very valuable also in that it can pass to your named beneficiaries without having to go through a probate, saving you on probate costs. It also gives you the privacy of naming your beneficiary without everyone knowing what was given to them. So, guarantees, no probate fees, privacy in beneficiary, all sounds good to me. From where I stand it would appear that everyone should have segregated funds instead of mutual funds, but there are certain drawbacks that have to be considered.

The main reason that mutual funds may be bought over a segregated fund is due to the management fees. Because segregated funds have all these built-in guarantees, it will usually come at a cost. Therefore, if you bought a mutual fund and you bought a segregated fund, over time the mutual fund will outperform the segregated fund. However, in a downturn or where a client is now older and wants to retain his principal, then it might be more beneficial to consider a segregated fund.