The following is a guest post from Glenn Cooke who is an independent life insurance broker at Life Insurance Canada.com Inc. My Own Advisor may or may not agree with the content below.
In this article, I’m going to compare life insurance company segregated funds against mutual funds for investment purposes within a Registered Education Savings Plan (RESP). Segregated funds can be a viable investment alternative for RESPs that many investors don’t consider, this post will help you do that.
For background, segregated funds or “seg funds” are mutual fund clones offered by life insurance companies. However, seg funds provide a guarantee on your capital/deposits over mutual funds. For example with some seg funds, after 10 years if your investments crash, the life insurance company guarantees at a minimum that you’ll have all of your deposits back. This guarantee typically comes in the form of higher fund fee costs (and thus lower earnings).
Seg funds are not normally advocated (well, not by some consumer advocates anyway) as a good choice for retirement planning. The long time frames involved with retirement planning mean the higher (expected) returns that come with other funds are likely a better choice. RESPs however are a different beast – there is a much more limited time frame – 18 years at the most and likely less than that. And much more concerning for investors as well. There’s a hard and short deadline for the RESP withdrawals. If markets crash right when your kids go to university, there’s no time for recovery – the money has to come out right then. With no time to wait for a recovery, this makes seg fund guarantees a good consideration for the cost.
So how much does it cost to get the seg fund, and is it worth the cost in order to cover the risk of a market crash? Let’s look at some numbers…
But first, our assumptions:
- Given this is an RESP, for our children’s education, our investments will be in a fairly conservative, low volatility fund.
- We are going to use Industrial Alliance’s (IA) Diploma RESP program for our seg fund. This program has a conditional bonus on deposits that we are going to include in the comparison.
- $100/month deposits occur to the RESP is assumed in all scenarios. Canada Education Savings Grants (CESGs) are ignored as they don’t impact the conclusions substantially.
- We’ll show calculations for 16 years and 10 years of contributions, if you started your RESP later in life.
- The ‘after crash’ scenario assumes a 50% drop in investments at the end of the deposit period.
16 years of deposits (total returns below):
|No Crash||After Crash (50% drop)|
|Mutual fund return @ 5%||$29,446||$14,723|
|IA seg fund return @ 5% with bonus||$32,326||$16,200 (guaranteed)*|
10 years of deposits (total returns below):
|No Crash||After Crash (50% drop)|
|Mutual fund return @ 5%||$15,592||$7,796|
|IA seg fund return @ 5% with bonus||$16,672||$9,000 (guaranteed)**|
*I assumed the guarantee is 100% of contributions for 10 years.
**I was conservative even with this guarantee.
It’s important to note that it’s easy to construct scenarios with assumptions that make either seg funds or mutual funds look better. The question is, are these assumptions reasonable? If we assume that my assumptions are reasonable (and let me know in a comment if you disagree), here’s the conclusions I draw:
- Seg funds vs. ‘safe investments’: seg funds win. Seg funds should outperform any type of ‘safe’ investment i.e., GICs. A seg fund even in a market crash should outperform the returns on many guaranteed investment products (like GICs). So if we’re concerned about volatility or a significant market crash, seg funds could be better than the other baseline guaranteed options.
- Seg funds vs. mutual funds over longer term: seg funds win. Over longer RESP contribution periods, seg funds will either perform the same as a similar cost mutual fund or be noticeably better in the event of a significant market crash thanks to the guarantee on your capital/deposits.
- Seg funds vs. mutual funds over shorter term: seg funds win. Over shorter RESP contribution periods, seg funds will outperform mutual funds on the upside, or significantly outperform mutual funds if there is a significant market crash. (Note: with retirement savings, the mutual funds should eventually come back and surpass the returns of seg funds. But remember – we don’t have the luxury of decades of contribution years with RESPs – the kids need to go to school).
In summary, if you anticipate any significant market downturn or you simply wish to protect yourself should a significant market crash occur, the guarantees associated with segregated funds might be something worth considering for your RESP.
With financial literacy month coming to an end, at the end of November, I want to motivate you to understand RESPs and use this account, whether you use seg funds, mutual funds, Exchange Traded Funds (ETFs) or other investment products. So Life Insurance Canada.com Inc. is giving away five (5) copies of The RESP Book plus $100 to drop into your kids’ RESP (giveaway now over) (or beer, whatever you feel is the best use of a C-note). To qualify to win, leave a comment on this site about RESPs AND include a link (URL) of this article with your comment as part of social media sharing. If there is no comment about RESPs with a social media shared link, there is no entry. (Note: contest rules updated at request of Life Insurance Canada.com Inc. on November 24th. Previous entries will be accepted.)
Mark will randomly draw five qualifying names on November 30, and we’ll send you a copy of The RESP Book along with an email money transfer for your $100. You need to be a resident of Canada and Mark’s decision on any raffle decisions will be viewed as final 🙂 Good luck!
- The views above represent Glenn Cooke and may not reflect those of My Own Advisor (Mark Seed).
- My Own Advisor encourages all investors to get a second opinion from the likes of a fee-only planner when in doubt about any major financial decision.
About the author: Glenn Cooke is an independent life insurance broker and president of Life Insurance Canada.com Inc.