The article “Segregated Funds: Are the Investment Guarantees Worth It?” was originally published on MoneySense on September 29, 2015.

When someone offers you a guarantee, it’s usually in their best interest, not yours

Q: We have recently retired and our financial advisor is very positive on us putting some part of our savings into a segregated fund, since it guarantees a minimum 3% annual return and a full return of capital in 10 years.

We like the security of this, but are concerned about the lost opportunity of having these funds invested in ETFs for the 10-year period even with the risk that markets could correct for some period of time.


A: I have a general rule of thumb about guarantees and it is that buyers should beware, Andy. When someone offers you a guarantee, it is usually in their best interest, not yours. Extended warranties, for example, are priced so that they are profitable for the offeror, not so that you are likely to come out ahead as a consumer.

Segregated funds are the insurance industry’s spin on mutual funds. They generally have a principle guarantee of either 75% or 100% of your capital after 10 years, or in the event of your death.

In the case of a segregated fund with a 10-year principle guarantee, the reason the offer is skewed in the favour of the issuer is that 10-year periods where stock markets go down are few and far between. In fact, since 1900, the only two short-lived periods when the S&P 500 was negative over 10 years were the periods ending in the late 1930s following the Great Depression and those ending in 2009 at the lows of the subprime mortgage crisis. So 99% of the time, 10-year returns were positive for U.S. stocks.

For Canadian stock markets, since 1960, more than 90% of the time the TSX has returned over 6% over 10 years. And in no 10-year period have TSX returns been negative.

What about that 3% return guarantee? The TSX has returned over 3% in more than 99% of the 10-year periods since 1960, Andy.

One thing that is also guaranteed about segregated funds in addition to the principle guarantee is high fees. Seg fund fees tend to be higher than typical Canadian mutual funds, which are high as a group to begin with. If you’re giving away 3% of your investment’s return each year in fees, you are almost guaranteeing that you will lag the potential performance of an ETF portfolio—let alone most mutual fund returns.

While there are good active managers who do outperform their benchmark over long periods of time, I’m afraid you’re not likely to find them running an insurance company’s segregated fund line-up. And few managers can overcome the 3% fee hurdle that most segregated funds are faced with in the first place.

The point, Andy, is that a 10-year principle guarantee is virtually worthless based on stock market history. It may sound good to a consumer, but stocks generally don’t go down over 10 years. A balanced portfolio of stocks and bonds is likely to beat the 3% you’ve been promised handsomely.

One point that investors should be aware of as it relates to segregated funds is that mutual funds are subject to new fee disclosure regulation that comes into place next July. Segregated funds are exempt. For some reason, the insurance industry has yet to commit to disclose fees the same way the investment industry has committed to in 2016. So segregated may be more appealing to advisors because they won’t need to disclose how much they’re getting paid to put you in them.

And I hate to be a pessimist, but the segregated fund will probably pay your advisor 1% a year for the next 10 years. If he’s not licensed to sell ETFs, he may not be able to offer them to you. Hopefully he’s told you that, instead of simply arguing why segregated funds are better.

And if he’s licensed to sell index funds—the mutual fund industry equivalent of an ETF—his own 10-year return in the form of a trailer fee from the fund company is likely to be less than the segregated fund would pay him. So it may just be that the seg fund recommendation is actually in the best interest of your financial advisor’s own retirement instead of yours.

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.