Investment Options

What this subject covers, and where our licence stops

Investment options is a wide label. On this site it means one thing: the vehicles a Canadian household actually chooses between when it decides where money will sit between now and some later purpose. Five families do most of the work. Segregated fund contracts, mutual funds, exchange traded funds, guaranteed interest options and annuities.

They do not all live under the same law. A segregated fund contract is an insurance contract issued by an insurance company, and so is an annuity. A mutual fund and an exchange traded fund are securities, and advising on either requires a registration that an insurance licence does not confer. Guaranteed interest options sit on both sides of that line, depending on whether the issuer is a financial institution or an insurer.

That division decides who is permitted to say what to you. This practice holds an insurance licence, so it can explain and offer segregated funds and annuities. It cannot give securities advice, it does not manage portfolios, and nothing here tells a reader what to buy. A securities decision belongs with a representative registered with the Canadian Investment Regulatory Organization.

The five vehicles, and what actually distinguishes them

A mutual fund pools money from many investors, buys a portfolio, and gives each investor units whose value follows that portfolio. It is a security. A unit is worth what the portfolio is worth, and nothing about it is guaranteed.

An exchange traded fund pools money the same way but trades on a stock exchange like a share, all day, at a price set by buyers and sellers. It is also a security. Most track an index rather than paying somebody to choose the holdings, which is why they usually cost less to own than a comparable mutual fund.

A segregated fund contract looks like a mutual fund from the inside and is not one from the outside. The money is invested in an underlying fund, but what the client owns is an insurance contract, and the assets are held apart from the general assets of the insurer. Because it is insurance it can carry features no security can carry, and it costs more to own than the fund it holds. The comparison article takes that apart line by line.

A guaranteed interest option pays a stated rate for a stated term and returns the money at the end of it. Nothing moves on the price side. What moves is purchasing power, because a rate fixed years ago meets whatever inflation turns out to be.

An annuity is the reverse of saving. A sum is handed to an insurer, which contracts to pay an income for a fixed period or for as long as the annuitant lives. It is the one arrangement here that removes the risk of living a very long time, and it does so by giving up access to the capital.

Three questions that decide most of the choice

Ask who carries the investment risk. In a mutual fund, an exchange traded fund and the underlying fund of a segregated fund contract, the client does, and a fall in the market is a fall the client bears. In a guaranteed interest option and in most annuities the issuer does, and the client instead carries the risk that a fixed amount buys less later than it would have bought at the outset.

Ask what it costs to own. All of these are paid for, and in most of them the payment is deducted inside the product rather than invoiced. The cost is known in advance. The return is not. That asymmetry is why fees deserve more attention than they usually get, here and in the article on fees.

Ask what happens at death. A security in a non registered account generally passes through the estate, which means it waits for the estate to be settled and, outside Quebec, is exposed to probate charges where a province levies them. An insurance contract with a valid beneficiary designation pays that beneficiary directly. That difference is often worth more to a family than any difference in the underlying portfolio.

What a management expense ratio actually pays for

A management expense ratio is the annual cost of owning a fund, stated as a proportion of the money in it and deducted from the fund itself. It pays the people who choose and monitor the holdings. It pays the administration: unit pricing, record keeping, custody, audit, statements and regulatory filings. In most funds it also pays ongoing compensation to the firm and the representative who sold the holding and continues to service it, the largest component in many of them.

In a segregated fund contract it pays for something more: the insurance features. The maturity and death benefit guarantees are underwritten risks, the insurer must reserve capital against them, and the cost of that sits inside the ratio. A contract with stronger guarantees costs more than the same underlying fund with weaker ones. A reader who does not want the guarantees should not pay for them.

Trading costs are charged to the fund on top of the ratio and disclosed separately. None of it is hidden. It is written in the Fund Facts document, or in the information folder and contract for a segregated fund, and both are free. Ask for the current one rather than trusting a figure from a page like this.

Why it matters is arithmetic rather than opinion. A cost is charged every year, on the whole balance rather than on the growth, so over a long period it compounds against the owner exactly as returns compound for them. A reader cannot forecast a return. A reader can read a fee.

The insurance features, each with the conditions attached to it

Four things come with a segregated fund contract that cannot come with a mutual fund or an exchange traded fund. Every one has conditions, and a description that leaves them out is worth nothing to the person relying on it.

The maturity guarantee promises that a stated proportion of the money put in will be available on a specific maturity date set by the contract, after a holding period counted from each deposit. It promises nothing on any other day. Money taken out earlier reduces the guaranteed amount, usually in proportion to the withdrawal, and a reset that locks in a higher value ordinarily restarts the holding period. The proportion varies by contract and by series, so read the contract rather than a summary.

The death benefit guarantee promises that on the death of the person named as the life insured the contract pays the greater of the market value and the guaranteed amount. It is reduced by withdrawals in the same way, it can be limited by the age at which a deposit was made, and it is the feature that most often justifies the extra cost for an older owner, because it removes the risk of dying in a bad year for markets.

A named beneficiary means the proceeds are payable to a person rather than to the estate. The money moves in weeks instead of waiting for the estate to be settled, and it is outside the probate process outside Quebec. The condition is that the designation must be valid and current. A beneficiary who has died, a designation contradicted by a later will where the law permits that, or a blank where a name should be, all send the money back into the estate.

Potential creditor protection is the one most often overstated. Where the named beneficiary falls within a protected family class, or the designation is irrevocable, the contract may be beyond the reach of the creditors of the owner. Whether it is depends on the province, on the facts, and above all on timing, because a court can set aside a transfer made when creditors were already circling. It is not automatic. It is a legal question that ends with a lawyer or a notary, and the article on creditor protection is the longer treatment.

The account decides the tax, not the investment

A common and expensive confusion is to think a fund is tax efficient or tax inefficient in itself. In a registered plan it is generally neither. Growth is sheltered while it stays there, and the tax question is about when and whether money comes out rather than about what kind of income it was. The account type, not the holding, sets the rules.

In a non registered account the kind of income matters a great deal, because interest, Canadian dividends and capital gains are each taxed on a different footing. The same two investments in the same two accounts can produce noticeably different after tax results depending on which sits where. See the article on investment income and the article on the inclusion rate.

Segregated fund contracts add one wrinkle worth knowing before it surprises anybody. Being insurance contracts, they allocate income and realised gains and losses to the contract holder each year in a non registered contract, including losses, which a mutual fund cannot pass through the same way. That is reporting rather than strategy, and what it means for a particular return belongs with a qualified tax professional.

Contribution room, withdrawal rules and the treatment of each account type are set by government and change. The article on registered accounts explains the shapes; for any current figure go to the Canada Revenue Agency and, for a Quebec resident, Revenu Quebec.

Risk, horizon, and the cost of your own timing

Risk is not one thing, and treating it as one is how households end up in the wrong place. There is the risk that a holding falls and has not recovered on the day the money is needed. There is the risk that a guaranteed return buys less at the end of a term than the same sum bought at the start. There is the risk of outliving the money, which grows rather than shrinks with age. Removing one of these usually increases another.

Horizon makes the answer specific. Money needed on a date that cannot move belongs somewhere its value on that date is known. Money that will not be touched for decades can carry variation, because time turns a fall into an episode instead of a loss. Most households need both at once, for different pots, and the mistake is to run the whole balance on one setting.

Then there is the part nobody markets, and it follows from how the two figures are built. A fund reports the return of a holding kept from the first day of the period to the last. An investor earns the return of the money actually in it, and that money tends to arrive after a rise and leave after a fall. Those are not the same measurement, the difference has nothing to do with fees, and it frequently costs more than the fee the same investor spent an evening comparing. Anyone who knows they will sell in a bad month should own something they will not sell.

What this practice does here, and what to read first

We can explain insurance contracts and offer them. Segregated fund contracts and annuities are within an insurance licence, and we will walk through a contract, a guarantee and the conditions on it with anyone, whether or not they buy anything. We cannot advise on a security, build or manage a portfolio, or tell a reader what investment suits them. Saying so is not modesty. It is the law.

If you are here for a comparison, start with the side by side. If the reason is estate treatment, start with segregated funds. If the reason is income that has to last, read annuities slowly, because it is the one decision here that is hard to reverse. No page can see the debts, health, dependants or temperament of a household, and those decide more than any product feature does.

Questions people ask