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Guaranteed investments aren't as good as they seem

The North American stock markets have been quite volatile these pastfew years, leaving many investors nervous and disillusioned about whatthey should be doing with their savings and retirement money.

The North American stock markets have been quite volatile these past few years, leaving many investors nervous and disillusioned about what they should be doing with their savings and retirement money.


Investors do realize the need to try and continue to grow their wealth but are finding it hard to invest due to the volatility in the marketplace. Many investors have been asking me recently about guaranteed investment vehicles. These are investments that pay a certain rate of interest or have the ability to grow in value, but also guarantee the principal. There are many investments that offer certain guarantees today, but are they worth the fees you are paying by owning them?

Some of the more known investments that offer guarantees are GICs and government bonds. Both of these investments are backed by the government, and thus have very little risk associated with them. However, what are you earning with these investments? At today’s rates, you could earn anywhere between 1.85 per cent and three per cent with these types of investments, which hardly keeps up with inflation. An investor that earns 1.85 per cent on a one-year GIC after tax and inflation (approx. 2-3 per cent on average) would actually have a negative rate of return on their money.

There are insurance products like segregated funds (*) that many investors turn to that not only guarantee your principal, but also allow for your money to grow. If you hold on to these products for a minimum of 10 years, the segregated fund product will guarantee your principal and when an investor decides to sell, they will receive their original principal back or the value of the funds, whichever is higher. This sounds like a great product right? Well, possibly not.


The segregated products that offer this guarantee, while great in theory, end up charging you more money for management fees than your average regular mutual fund product would. Thus, you are paying a little out of pocket for this guarantee. We also know there have only been six five-year periods since 1954 where investors have lost money. Thus, the odds of an investor losing money over a 10-year period in my estimation are very low. So, why is the guarantee necessary?

There are other products that pay a guaranteed rate until retirement and pay fixed amounts on an annual basis to investors during retirement, as well. These products are very enticing to investors once they stop working because they know, no matter what, that they will be receiving a certain amount of money per year.


However, from my experience with this guaranteed program, the types of investments available to own are limited and there is not much flexibility with the products either. In my opinion, an investor would be better off in many instances, purchasing a government strip coupon bond that would guarantee your total principal and then the investor would be able to invest the remaining portion of the portfolio into a diversified group of investments. With this investment strategy, the government bond will act as the guarantee for the entire portfolio and you have the flexibility to buy whatever investments you want without worrying. This strategy can also be more cost effective as well.

Therefore, the answer to the question of whether an investor should be in some sort of guaranteed investment today will depend on the type of product, but also what makes more sense logically and emotionally. Many guaranteed products from a logical viewpoint, in my opinion, are just not worth it.

(*) Insurance products provided through Dundee Insurance Agency Ltd.


If you have any questions regarding the above article or are looking for an Investment Advisor to help you with your portfolio, please send me an email at asmall@dundeesecurities.com. I will be glad to speak with you.



Allan Small is an Investment Advisor with Dundee Securities Corporation, a DundeeWealth Inc. Company. This is not an official publication of Dundee Securities and the author is not a Dundee Securities analyst. The views expressed are those of the author alone, and are not necessarily those of Dundee Securities or Metro Canada.

 
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