Segregated Funds, also known as Guaranteed Investment Funds (“GIFs”), are professionally-managed investments.
Similar to mutual funds, investor money is pooled together and invested in stocks, bonds or other financial securities. The investor will purchase units of a fund of their choosing and the investment manager is responsible for the performance of the fund. Investors can choose from a wide variety of funds that will ideally align with their risk profile.
Why invest in a Guaranteed Investment Fund (“GIF”)?
- Diversification
- Access to a professional investment manager/firm
- Ability to efficiently invest in different sectors and regions
- Ease of implementing Dollar-Cost Averaging
- Contractual guarantees against market downturns
- Possible creditor protection
- Estate planning benefits:
- No probate fees
- Confidentiality
- Beneficiaries receive funds much quicker than going through the will
Diversification is crucial to any investment strategy and follows the mantra of “not putting all your eggs in one basket.” An investor could have many different investment funds within their GIF contract.
The mandate of the investment manager/firm is to maximize the investor’s return; the investor’s job is to ensure they have selected a fund that is consistent with their overall investor profile. An investor profile will be determined based on an IPQ (Investor Profile Questionnaire). The IPQ will ask about investment experience, net worth, income, tolerance for market fluctuations, time horizon, amongst other things.
If you are an investor that is bullish on a particular sector or region, such as Asia, for example, you can choose a fund that has holdings in that area. This is an extremely efficient way of gaining exposure to specific markets.
Dollar-Cost Averaging refers to regular, pre-determined contributions to your investment fund(s). This is done regardless of how the markets are performing and is the opposite of “market timing.” The intrinsic benefit of Dollar-Cost Averaging is when the investment fund is higher, the investor’s contribution will result in fewer units purchased; vice versa for when the fund is lower. This is, in a sense, “buying low and selling high.”
Points #5-7 above are unique to GIFs and serve as the fundamental difference when they are compared to Mutual Funds. This is because GIFs are sold by insurance companies. What does this mean for investors?
Investors are provided with protection against market downturns in the form of maturity and death guarantees, as well as “resets” that lock in investment growth. The guarantees are either 75% or 100% and would come in to play if the investor’s contract matured or they passed away while their investment dipped below their “guarantee” threshold. Let’s look at an example:
Betty invests $100,000 into a GIF with a 100% death guarantee. Six months from the inception date, Betty passes away. During the 6-month period, the markets had a rough stretch and her investment dropped 5% in value, to $95,000. Due to her contractual guarantee, the company who provided the GIF will “top-up” Betty’s investment by $5,000, bringing it back up to $100,000. Betty’s named beneficiaries will now receive the full amount of her initial investment.
If a GIF investor names specific beneficiaries, such as a family member, their investment may be protected during their lifetime against creditors. On death, the investment account will be paid directly to the named beneficiaries, so there will not be an opportunity for creditors to access the investment capital. Creditor protection is built-in with certain registered accounts, but the above applies to non-registered accounts.
Lastly, building off the creditor protection theme, the most compelling feature for GIFs applies to non-registered accounts. A non-registered account is essentially any investment account that is NOT a pension, RRSP, TFSA, or other government-offered vehicle. Non-registered accounts are “after tax” accounts, also referred to as “cash” accounts. GIFs permit named beneficiaries on non-registered investment accounts, which provides immense value for estate planning. By naming beneficiaries, the investment fund bypasses the will on death. This leads to the following:
- No probate fees, which are ~1.4% in BC. On a sizeable investment portfolio, this is significant.
- Confidentiality – wills are public documents. For those who value privacy with their financial affairs, GIFs provide just that by passing outside of the will/estate.
- Quicker payouts for named beneficiaries. Probating a will is an incredibly slow process and can lead to loved ones being on the hook for final expenses while having no access to the estate’s capital. GIFs can be paid out to beneficiaries within a matter of weeks (compared to potentially years via the will).
What about the higher fees?
When compared to Mutual Funds, the investment management fees for GIFs are higher; but not by much. Let’s take a look:
- RBC Balanced Segregated Fund Management Fee (known as Management Expense Ratio): 2.22%
- RBC Balanced Mutual Fund Management Fee: 2.16%
A mere 6 basis points (0.06%) differs between RBC’s balanced mutual fund and GIF. On a $100,000 investment account, that equates to $60/year – are the above estate planning and creditor protection benefits mentioned worth $60 per year?
The 2.22% mentioned above would apply to a 75% maturity and death guarantee on the GIF. The fees increase to 2.72% for a 100%/100% guarantee, so if the added downside protection was important, it can be added for an additional 0.5%.
Summary
There is no shortage of desirable investment options for Canadians. GIFs offer active professional investment management, diversification, and simplicity to implement Dollar-Cost Averaging. If someone is also concerned about simplifying their estate and wants a safeguard against significant market downturns, GIFs become an unparalleled option for investors.
Speak to Jeff Graham about GIFs; he can be reached at (604) 363-7549 or jeff@firstoakfinancial.ca.
DISCLAIMER: this commentary is provided for general informational purposes only and does not constitute financial, insurance, investment, tax, legal or accounting advice.