During the RRSP campaign, I met one of my clients who held investments with Manulife for a while. During our meeting, he showed me his investment statements from the other company. He had invested in segregated funds for the past 10 years and wasn’t happy with the results. While I am not bashing Manulife (I still took it in my portfolio for our best 2010 stock picks contest ), I can’t say that I am a big fan of Segregated funds either!

What is the difference between a Segregated fund and a Mutual fund?

Segregated funds (also called seg funds) are one of the strange beasts created by some crazy financial scientist in the labs of insurance companies. They are very similar to mutual funds when we look at their investment composites. If you look in your track investment apps you will see that there are seg funds for every kind of investor profile. However, when you call a life insurance investment services, they will explain the difference between segregated funds and mutual funds.

Segregated funds are held within a life insurance policy. This means that they are part of the policy paid to your beneficiaries if you decease.

Segregated funds usually come with a partial to full capital guarantee. The term to benefit from this guarantee is usually 10 years. After this period, your capital can be guaranteed at 75% to 100%.

Segregated funds: paying a high price for a small security

As you can see, Seg funds are quite similar to mutual funds. However, there are some major cons of buying them.

#1 Seg funds have higher MERs

Management ratios is one of the most important metrics you need to analyse when looking at an investment. If your fund has a 3% MERs, this means that you start January 1^st of every year with a yield of -3%. It can be hard for a fund manager to overcome this obstacle.

You won’t be surprised that segregated funds have the highest MERs in the  world funds. This can go from 0.25% to 1% more than a management fee on similar funds without the guarantee of capital.

#2 Does the segregated fund security of capital really worth it?

When you think about it, most balanced mutual funds are showing positive results over a 10 year period. And rarely you will see a fund returning only 75% of their value after 10 years. However, if you are doing selective and highly speculative trades (like buying techno funds in 1999), your guarantee can be worth something today. But if you follow an established asset allocation, you would never need this kind of guarantee over 10 years.

#3 Other segregated fund fees

You may think by buying an investment fund with MER fees 30% higher than others that you would be done with fees. Well, my friend, you may also end-up paying both front end and back end fees. While front end fees are usually waived by the advisor (who is looking for his commission after all ), the back end fees are usually in place (which guarantees the advisor a higher commission pay check at selling and trailer fees for at least 5 years. if you don’t want to pay fees to sell the fund).

Final thoughts on segregated funds

As you can see by now, I don’t really like seg funds . If you are really looking for capital security and still want to benefit from the market growth, I suggest you consider linked notes. You will still be paying a high price (in my opinion) for security but you will get a better return (if you take the time to buy the right one ).

Do you have seg funds in your portfolio? How are they doing? Do you like them?

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Guest post by By The Rat

Biography For The Rat

The Rat is a young Canadian investor and entrepreneur hailing from the east coast.

After earning a Bachelor of Commerce in the Maritime Provinces, he returned home at the age of 21 to work in various capacities, most of which were in the private sector. There, he had the opportunity to accumulate over ten years of business experience in a range of senior management levels, take advantage of real estate opportunities, and invest in equities and other types of investment vehicles. In January 2010, he was able to retire and hence “end the rat race” in his early 30’s.

Going by the pen name ‘The Rat’, the author has etched out and created a small place in cyberspace through his website “Ending The Rat Race” with the intent to provide value to readers both in terms of content and sharing of real-life experiences.

Officially launched in September 2008, Ending The Rat Race is a personal finance blog that has as one of its key purposes, the sharing of various personal finance topics with others having similar interests, and learning from one another.

Do you know that if you had 100% of your portfolio into equities during the financial collapse, or more specifically during the periods of June 2008 to February 2009, you could have lost upwards to 43% of portfolio value?

How many people do you know or talked to during the financial crisis that mentioned they had lost almost half of their portfolio value, in a time frame that felt as though it was overnight? I have definitely heard a few of these real-life stories, and at the same time I have also learned from some of my own, costly mistakes to say the least.

For example, I have had discussions with people who were invested primarily in mutual funds, and because they took the advice to invest in a ‘well-balanced’ collection of funds, each of which were primarily invested in a basket of equities, were ‘hung out to dry’ during the market meltdown.

We didn’t have to go far to hear the horror stories. One of my previous threads, discusses a family (the Rossis) who were featured in a November 2009 MoneySense article titled, “From Rich To Ruin” and had lost over 40% of the value of their $314,0000 RRSP nest egg. This is an example of a ‘nightmare on wheels-type story’ where their adviser selected their funds for them. During the interview, one of the family members mentioned, “I would have been happier had we buried our money in a mason jar in the backyard”. This type of comment really hits home.

Some may say that despite the above mentioned, markets have recovered rather nicely since the financial collapse and that had the Rossis or others not panicked, the value of their respective portfolios would have likely rebounded quite nicely by now. Perhaps this is true to some extent, but not everybody has the same risk tolerance. I know that if I had kids and a family under a roof and all of a sudden I was forced to witness losses in the tens of thousands of dollars in a very short period of time, I would have been worried.

The interesting statistic I referred to in the opening paragraph stems from a November 2009 MoneySense magazine article, written by Suzane Abboud.  Adequately titled, “Better Crisis Next Time”, Suzane Abboud clearly demonstrates the importance of asset allocation in an investor’s portfolio and that sometimes a “do-it-yourself strategy” without all the fees may be a better approach to managing one’s portfolio. Even though the example I provided at the beginning of this thread falls under one of Abboud’s worst cases, it does highlight the fact that even typical balanced funds, which “holds more than 50% of its portfolio in bonds and cash” still experienced an “average loss of 23.5%” because of all the management fees and the fact that these investors had not taken a do-it-yourself approach.

In my view, what is really important to highlight from Abboud’s finding is her ‘take-no-prisoners’ approach to being clear and concise as it relates to the whole experience of the market meltdown. For example, she states, “Your experience during the recent market turmoil should determine your asset allocation going ahead. If you lost sleep, or couldn’t eat, at the very bottom of the bear market this past year, you should never put yourself in that position again.”

I believe the message that really stood out to me was when Abboud mentions, “If you want to make sure that your portfolio is not going to go down by more than 15%, you should not hold more than 40% of your money in stocks.”

As a result of the financial collapse and what I had witnessed within my own portfolio, I made some important changes. I had to look myself in the mirror and come to terms with the fact that 100% of my portfolio was in equities, and I had also been ‘chasing yields’ in the Oil & Gas sector with the thought of never-ending lucrative yields. One of my most important threads I ever posted, (despite its short length) was My Asset Allocation, mainly because I had reached a sense of realization as to how my investing strategy would be carried out on a go-forward basis.

My intent of this post is not to give readers the impression that “this is what you should do with your investments, and how you should go about doing it”. Instead, my purpose is to stress how important it is for investors to be cognizant of the risks associated with having the wrong asset allocation. Now that the ‘dust has settled’ somewhat with respect to the markets, we quickly realize the importance of one’s asset allocation as the economy and markets take wide swings. It’s up to the individual investor to bulletproof their respective portfolio given their own risk tolerance and investment style – by choosing the right asset allocation, this can be accomplished.

If I had more ‘safety’ in my portfolio during the financial collapse, I’m sure I would have witnessed much less volatility and loss of portfolio value had I had a more effective asset allocation. Lessons learned indeed.

What about you? Have you changed your asset allocation as a result of the financial collapse? Are you comfortable with your current asset allocation?

image source: ieshraq

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I swear to God, some people walk into a bank thinking it is a McDonald’s!

A colleague of mine walked into my office the other day with her eyes so big they were ready to pop out of their sockets.

“Have you seen this? ING is offering 3% (annualized rate) for the next 3 months on an RRSP contribution! This is way more than what we offer!” she said, panicked by the thought of losing accounts to the big orange online monster.

“So what?” I replied almost as interested by her announcement as I was when they said there were going to add a bus line on Sunday morning.

“How can I compete with this? The Bank won’t budge on their GIC rates and we are so far away from this offer!” she insisted (that’s it, I think her eyes dropped from her head and started some break dancing on my desk).

“Do you know that if your client invests $5,000 for 3 months at a 3% rate (annualized) he will make about $35? How can you not compete with a huge profit of $35? What is your client going to do in 3 months since he will only retire in 30 years?”. I knew the answer: he will transform himself into another rat (i.e. rate shopper!). But the key is that he won’t get much from jumpin’ from one rate to another (especially with the marvellous rates we have in the industry!).

Unfortunately, some people prefer to see financial advisors as trustworthy as mechanics or politicians. Therefore, they prefer to trust themselves and invest in something they understand. 3%. That, they understand. They don’t figure it’s only for 3 months and that they won’t do much after this period. They understand the 3% concept and they are happy with it.

The key point is not to manipulate our clients and make them invest in something else. The point is to help them understand that they are losing their time and most importantly their money chasing ridiculous rates for 3 months when they won’t be touching this money for the next 30 years.

Each investor should have a plan. He should know how much he invests, where he invests and (most importantly) why he does it this way. If you are investing without knowing the answers to those 3 questions, you are not investing in the right way. Then, you are in serious trouble and I hope you are putting a lot of money aside because you won’t make it to retirement…

Notice that I didn’t talk about how much you will make. This question is useless as nobody knows the real answer. However, if you stay invested during the next 30 years, you should be making around 4 to 6% depending on your investor profile. In any case, it will be better than investing in GIC’s!

I have living examples to prove it: I had looked at one of my clients who invested his money in an investment strategy back in 2004. As of the end of 2009, he was making an annualized return of 5.13% (with a balanced fund). While he was making more than any 5 year GIC back in 2004 (they were giving about 4.50% to 4.75%), it was also tax efficient and liquid at any time. In addition to that, we have to mention that his portfolio went through the worst investing period of all time. Therefore, I am ready to bet that he will be making much more than 5% annualized rate at the end of 2010 while the other individual will have to renew his money at 3% for 3 months…and then… 3% for the next 5 years?

Next time you see an investment promotion, don’t ask yourself if it’s a good deal or not, ask yourself if it fits your investing strategy or not

image source: Beau B

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Last week, I attended our monthly financial planning meeting where we  reviewed the current and upcoming economic situations and learn about our trading department’s expectations about the market.

I am always eager to know which observations have been made by our trading floor and their potential to see the future. But more than this, what I really like about these meetings is to see how they translate economic signs into market trends.

Don’t worry, I am not going to delve into the marvellous world of predictions (there are plenty of financial reporters to do that ). I did, however, want to bring up an interesting point if you are looking for investment ideas for 2010: Bonds will be riskier than equities!

Say what? How can a “relatively” secure and guaranteed investment be riskier than “volatile”, unsecured shares of a public company? This is because of the bond value mechanism!

In fact, if you are looking for investment ideas for your 2010 RRSP, you should look towards equities for 3 reasons:

#1 Bond values drop when interest rates go up

If you want a full explanation as of to why bonds go down when interest rates go up, I suggest that you read this article over at Gather Little By Little. In a few lines, let just say that each time interest rates go up, existing bond values drop to reflect the new interest rate environment. Therefore, the buyer of an existing bond, will pay lower than it’s initial (face) value (let’s say $980 instead of $1000) and the $20 difference, he will receive at maturity (because the company will pay him back $1000 even if he had paid only $980), will be added to the current interest rate of the bonds to mimic the new (and increased) interest rate on the market.

Since everybody agrees that interest rates should slowly go back up toward the end of 2010 /  beginning 2011, bond value4 should drop accordingly during this period.

#2 Bonds are offering very low interest rates right now

Combined with the fact that new bonds are offering very low interest rates, if they have to drop in value, chances are that your yield will be around 0%…. or even worst; some bond funds or mortgage-backed funds will probably show negative returns in 2010 – 2011. Not the best investment ideas then .

#3 We still have another 25% + to reach the market highs of 2008

On the flip side, stock markets are down at least 25% from their market highs of 2008. In some cases, the appreciation required is more than 30%! While I won’t say stock markets will recover fully from all their declines in 2010, chances are that they will continue to appreciate during the next 12 months. Economic data are stronger and several companies show liquid assets and profits.

Investment Ideas for 2010:

So based on these premises, I have selected a few investment ideas for 2010. Since I think that the stock market is a safer place than bonds, I have only picked equity related investment solutions:

#1 Variable Rate CD’s

While variable rate CD’s and linked notes are not part of my favourite investments, this is probably your only option if you wish to keep a guaranteed investment that will beat the inflation over the next 5 years. The market offers about 3% for a 5 year certificate of deposit. Do you really think that inflation won’t take at least 50% of this yield in the next 5 years? This is why variable rate CD’s is a great investing ideas for 2010. They offer a guaranteed investment while their yield is linked to different stock markets. Make sure to understand how it works and ask several questions to your financial advisor before going with this option.

#2 Packaged Mutual Funds

If you don’t know much about how the stock market works but you don’t worry too much about your portfolio fluctuations, you can look at packaged mutual funds. Funds are invested according to your investor profile to make sure they respect your risk tolerance. The good side of packaged mutual funds is that they are automatically rebalanced every 6 months to make sure they stick to your investing strategy. Therefore, you don’t have to actively follow your investments. While packaged mutual funds are great investing ideas, they also show very high management fees (MER’s).

#3 ETF’s

I really like ETF’s since their MER’s are pretty low and you buy what you want to follow. There is an ETF’s for anything you want to follow from stock indexes to industries or commodities. I would say that the major downside of ETF’s is that there are too many out there . If you decide to build a ETF’s portfolio, make sure to follow it and rebalance it every 6 months. If not, you may have a big surprises!

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It was a dark autumn night; the cold wind was whipping our red cheeks filled with blood to keep us warm. A few leaves were still dancing in the rain over the suburban cemetery exposing their dead sisters in front of each house. While a few monsters were crawling the streets in search of fresh and juicy candies…

But the worst was yet to come… Draguflaherty was arise from the dead and make a declaration: The Canadian Income Trusts will be taxed as a normal companies!

This happened on October 31^st 2006 and swiped the Canadian market faster than the first snow of winter. Back in 2006, there was 254 income trusts. Since the dark reaper cut their throats, and now  there are only 170 income trusts left. Most of them will convert back to regular incorporations by the end of the year.
 
 
 
 
 
 

Income Trusts’ Tax implication will change in 2011

As of January 1^st 2011, all income trusts will be taxed as regular incorporations. The major difference since its creation is that income trusts were able to distribute their dividends tax free and were getting taxed only on the money remaining after the dividend distribution.

The Canadian Government decided to put a stop to this madness as more and more companies were converting into income trusts taking away billions of dollars of tax revenue from the Government.

Real Estate Income Trust (REITs) will be the biggest winners

There is a survivor to this story and they are real estate income trusts. In fact, they are the only ones to keep their tax privileges. Therefore, even though investors already assessed the dividend cut from other income trust, we expect the remaining trusts to drop in value while REITs should show some interest.

Is there any alternative to high yield dividend paying income trusts?

#1 REITs

As previously mentioned, REITs’ tax situation will remain as is. Therefore, it is probably the best possibility in order to receive a high dividend. The housing market is good in Canada but it is not impossible to see a housing bubble in our country too. This is why I would not shove all my money into REITs. Nonetheless, they certainly have their place in a balanced portfolio.

#2 Oil Income Trusts

Oil income trusts are no different from other trusts as they will be taxed starting 2011. However, their major expenses in infrastructures will allow them a tax break for a few more years. Hence, this could be a way to “ride the wave” for a couple of years. There are very solid companies out there and those picks could help your fixed income to perform in 2010.

#3 Canadian Banks

While they are far from being treated as income trust, Canadian banks are among the most solid financial institutions arond the glob. As previously mentioned in my last update of the TSX 60 dividend yield, 4 out of the 6 biggest banks in Canada show a dividend yield over 4%. Their solid balance sheets also contribute to maintaining such a high dividend. According to me, they could be seen as the “small version” of an income trust .

#4 Preferred Shares

Preferred shares can also become an interesting option. Less volatile than common shares, they also offer higher yield. You can find the major banks, insurance companies and oil corporations. They took a major hit in 2008 but most of them came back from the dead and their dividend payout is similar to income trusts (considering lesser risk to be assumed).

Final thoughts on Canadian Income Trusts

I have mentioned it several times on this blog: there is no free lunch in finance. Therefore, what used to be a free ride to high paying dividend investing products finally disappears. Investors will have to get back to investing basics by considering the financial fundamentals of a company instead of picking any double digit dividend yield without even looking at the income trust name!

image source: pingu1963

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