Are seg funds worth the premium?

Question

My wife and I have $180,000 in an RRSP at our bank and another $175,000 in an RRSP with an insurance company. The RRSP with our insurance company is in some kind of investment that is guaranteed not to lose our money. It holds a basket of 10 mutual funds with MERs ranging from 2.5% to 3.99% and all of them carry back-end loads/deferred sales charges. But this investment has not made a dime in years. We are 54-years-young and would like to see some positive growth. Any suggestions?

Answer

Buying insurance can be tough. You absolutely must have it on your car to be allowed on the road. You really should have it on your life, if you have a family. But does it really make sense to get insurance on your investments? Insurance comes at a cost and you have to decide it’s worth the price.

I have been thinking a lot about the cost-benefit equation on insurance recently. In fact, I reached out to my insurance broker just last week to ask her to price some additional coverage. She came back with a surprising answer: If I were to change my policy it would lead to a 20% increase in my premium. Ouch. That additional insurance I was looking for was simply not worth the price, in my opinion.

Segregated funds simplified

The product you’re talking about is called a segregated fund and its benefits have been hotly debated over the years. These funds are similar to traditional mutual funds in that they hold a diverse range of securities. There are other differences too, but the most relevant to you is the fact that they are sold by insurance companies and have certain protections built in. For example, your “seg” fund has a “maturity guarantee,” which means that you’ll get a certain percentage of your money back at maturity, regardless of how the market has performed. The fund might also include a guaranteed death benefit or a feature that provides protection from creditors.

But that added protection comes at a cost and you’re paying for it through the higher management expense ratio. That is certainly part of the reason why your fund “has not made a dime in years.” The question is, do you really need that coverage?

Multiple ways to manage risk

A segregated fund is one way to protect you and your wife from the risk of not having enough money in retirement. But there are multiple ways to manage risk—investing more of your portfolio in boring old government bonds, for example. Diversifying your portfolio across regions, sectors and asset classes, perhaps including real estate in the mix are some additional options to consider. You could also choose to work longer if your nest egg isn’t large enough to support your retirement goals. After all, you are both only 54 so you have more time to weather market volatility than you would if you were 20 years older.

One thing people often forget is that you don’t need access to all of your retirement savings the day you stop drawing a paycheque. You need income to help you buy groceries, but that could come from bond income, or from selling a bond mutual fund or ETF. The point is, you shouldn’t have to cash in a mutual fund while its value is depressed because you have other assets to rely on while you wait for the stock market to rebound.

Finding a great financial adviser

You currently have almost $400,000 saved up between your two RRSPs so you shouldn’t have a hard a time finding a fee-based financial adviser to take you on. There are two reasons why I think you should get some expert assistance on this.

The first is that you’ll benefit from someone who can help you get out of the segregated fund. There will be some math involved to calculate how and when to sell at the lowest cost to you. That’s because there may be a penalty for early withdrawal, plus you may have to pay the back-end load (also called a deferred sales charge) and you won’t qualify for the guarantee because you aren’t keeping your money in the fund until maturity. A great financial adviser will factor in all these variables and tell you whether to bite the bullet and sell now, or hold on for a few more years to avoid the penalty and back-end load.

The second reason why I think you should consider paying for an adviser is that you need to create an overall investment plan. This involves stepping back and looking at your goals across a broad range of areas—home, travel, career, family and of course retirement. Then you need to develop an investment strategy that will help you achieve those goals. Per my comments above, this would include an assessment of your tolerance for risk, both in financial terms and in emotional terms, and a plan to manage it. You could do this work by yourself of course, but you may not have the time or inclination.

You are right to question if a segregated fund is a good fit for you—or if the price of this type of insurance protection is simply too much to pay.

About Bruce Sellery

Bruce Sellery is the CEO of Credit Canada, the country’s longest-standing non-profit credit counselling agency. He is a former MoneySense columnist.