Do you own a pooled investment? Do you know if it is a mutual fund or a segregated fund? Do you know the difference between the two and when each is better than the other?
Here is a table that compares the two from RBC Insurance.
| Features | Segregated funds | Mutual funds |
| 1) Professional portfolio management | Yes | Yes |
| 2) Diversification among assets classes and management styles | Yes | Yes |
| 3) Grow a portfolio while diversifying risk | Yes | Yes |
| 4) Liquidity: easy access to your money through daily price valuations | Yes | Yes |
| 5) Ability to bypass probate and keep financial affairs private | Yes | Sometimes |
| 6) Potential creditor protection for registered accounts | Yes | Yes |
| 7) Potential creditor protection for non- registered accounts | Yes | |
| 8) A guarantee of the principal (or a specified percentage) at maturity | Yes | |
| 9) A guarantee of the principal (or a specified percentage) at death | Yes | |
| 10) Lock in market growth using resets | Yes |
Let’s go over each of these points individually to see what they really mean.
- Professional Portfolio Management
There is a team of investment professionals that are making the decisions on what to own and when to buy and sell them
- Diversification Among Asset Classes and Management Styles
There are lots of different mutual funds and segregated funds available for you to purchase. Last time I checked, there were over 8000 different mutual funds available for sale in Canada .
- Grow a Portfolio While Diversifying Risk
Both mutual funds and segregated funds are pooled investments where you buy one product and that one product contains many different investments. - Liquidity: Easy Access to your Money Through Daily Valuations
Bot mutual funds and segregated funds can be sold at the end of any business day. - Ability to Bypass Probate and Keep Financial Affairs Private
Probate is the legal process that validates a will. Because they are done through the court system, they become public record. Because segregated funds are insurance products, the distribution of their proceeds do not need to go through probate. Depending on how a mutual fund account is set up, this is also possible with a mutual fund account.
- Potential Creditor Protection For Registered Accounts
There are rules in place that do not allow creditors to go after your registered accounts in bankruptcy or even other lawsuits. Registered accounts include RRSPs, TFSAs, RRIFS, and other investment accounts.
- Potential Creditor Protection for Non-Registered Accounts
Because segregated funds are insurance products, they are not able to be accessed in the event of a lawsuit. Mutual funds in non-registered (or cash) accounts do not offer this protection. This can be a good reason to use a segregated fund if you are investing money inside a corporation and are worried that you or your company may be successfully sued for something you have done. - A Guarantee of the Principal (or a specified percentage) at Maturity
- A Guarantee of the Principal (or a specified percentage) at Death
We will look at 8 and 9 together since they are the same protection that pay out at different times. Mutual funds do not have any guarantees on principal. This means that you can lose money when investing in a mutual fund. Segregated funds offer principal guarantees which means that you will be guaranteed to be able to withdraw a percentage of your initial deposit (less any redemptions) either at maturity or at the time of your death. Most segregated funds now offer something called a 75/75 or a 75/100 or a 100/100. The first number is the guaranteed percentage of your deposited money that you can cash out regardless of the market value of the account upon maturity (which is typically 10 or 15 years in the future). The second number is the percentage of your deposited money that your beneficiaries will receive upon your death. Let’s repeat that:
The typical segregated fund offers a guarantee that you will be able to withdraw 75% of your initial deposit upon your death or 10 years after your last deposit. - Lock In Market Growth Using Resets
Locking in your market growth means that at certain times (daily, or monthly or quarterly or annually depending on the insurance company) you can reset your deposit amount to the highest achieved market value by resetting the time to maturity. This means that if you deposit $10,000 but the account grows to $15,000, you can reset the account which would restart your time to maturity but would make it so you are now guaranteed $15,000 upon maturity or death on a 100% guarantee.
To recap, mutual funds and segregated are the same type of investments but segregated funds offer a principal guarantee, creditor protection and probate avoidance on non-registered accounts. The question to ask is who might benefit from these three advantages. The answer is people who are putting money away exclusively for their beneficiaries, corporations with large investment accounts and the risk of being successfully sued and people who do not want portions of their estate to become public record.
What is the downside of these benefits? The answers are cost and tax efficiencies. Segregated funds in non-registered accounts have no way to reduce tax implications unlike mutual funds which can use tools such as return of capital and corporate class structure to reduce taxes. Segregated funds typically charge a management expense ratio (MER)of about 0.4% to 1.5% more than the exact same mutual fund. Here are a couple examples.
Invesco Intactive Balanced Growth vs
Equitable Life Invesco Intactive Balanced Growth 75/75
Mutual Fund MER*: 2.28%
Segregated Fund MER*: 3.01%
Difference: 0.73%/year
Sentry Global Monthly Income vs
Canada Life Global Income (Sentry) 100/100
Mutual Fund MER*: 2.28%
Segregated Fund MER*: 3.16%
Difference: 0.88%/year
*numbers as of information available on September 15th, 2019
