Financial advisors must make investment decisions for their clients based on whatever information is available at that moment, not unlike the physician who must make a diagnosis with limited information about his patient’s condition.

The best advisors ask lots of questions and keep copious notes. Most advisors rely on the standard financial planning dictum of preparing a risk analysis, and cite everything from historical returns to the results of Monte Carlo simulations. It is also customary to prepare an Investment Policy Statement. In the end, you gauge all of the factors and make an informed investment decision. Only time will reveal if your decision was exactly right for the client.

The best investment a client can make is a written, comprehensive financial plan that provides a realistic look at the options for retirement income. It may mean some lifestyle adjustments, but this is exactly the advice the client needs from you. Only after the plan is complete can investments be appropriately selected.

Let’s revisit a few words of financial wisdom from Mark Twain. The beloved American writer and orator was raised in Hannibal, Missouri in 1835. Twain saw the end of slavery, the opening of the western American frontier and the industrialization of eastern America. It was a time of great risk-taking by many. Twain himself tried gold mining, and failed. He made a great deal of money from his writings and lectures, but squandered it on various ventures and was forced to declare bankruptcy.

These experiences gave him perspective on investing: he said, “I am more concerned about the return of my money than the return on my money.”

This brings me to a story of how a segregated fund maturity guarantee produced a satisfactory outcome for a client. My new client had been previously counselled by another advisor to invest in an aggressive tech fund portfolio at precisely the wrong time: February 2000.

When I met the client, he brought me his statement, which showed that 10 years later his original investment of $25,000 now had a market value of about $9,500. I found his previous advisor had chosen a segregated fund into which to place the original investment. Within a few months the client could exercise his 10-year maturity guarantee, raising the value of the investment back to $25,000.

The client was relieved, and although he had made no money, he had his original capital to reinvest. Since he is a cautious client, it was no small surprise he chose to reinvest in another segregated fund.

Critics of segregated funds often disapprove of their high management expense ratio. My clients have never complained about the cost; they focus entirely on the benefits. A low-cost ETF or some similar fund simply could not have delivered the same results.

In a second case, the value of a segregated fund’s death guarantee was put to the test. One day, my client told me he was undergoing cancer treatment and wanted to invest some funds he had accumulated. He had endured a difficult divorce and wanted to ensure that all of the proceeds of his estate would reach his children without any interference. My advice was to utilize a segregated fund with a 100% death guarantee, and to name his children as beneficiaries. This appealed to him, and the next day, a large cheque accompanied the signed segregated fund contract.

For several months, I heard little from him, except that his treatment was
proceeding. Then, about six months later, he called to tell me his illness had progressed to terminal. In the meantime, the capital markets had experienced one of those unpleasant, but temporary, declines. He asked me about his account and I assured him that while the value had decreased a small amount, there was a guarantee of principal should he not survive the illness. That was the last time I spoke to him. Within days, he was gone.

When his children contacted me, I told them all that was required was a death certificate and a letter of direction providing specific instructions in order for them to receive their inheritance. The process was seamless, and the money was sent directly to the children within 21 days. One child remains a client to this day. In response to those who decry the costs associated with managing a segregated fund, my client and his family never raised the issue. Once again, the benefit—the death guarantee and the peace of mind it brought to my client—far outweighed the cost.

The final example of the value of a segregated fund involves advanced retirement planning. As every advisor knows, the last few years of market turbulence have forced many clients to become so fearful of capital loss they have retreated to investments with perceived capital guarantees.

This reminds me of a quote by Will Rogers, a popular American humorist from the 1920s. Rogers and his audience were all too familiar with the booms and busts of the developing American west. When asked about investments, he famously commented, “Even if you are on the right track, you’ll get run over if you just sit there.” His advice still resonates today. Waiting for an interest rate increase or other desirable event is not an option.

Investors are facing the lowest interest rates in modern history. At the time a retiree is in need of income from his or her investments, he or she is being forced to accept 2% to 3% returns. You need a lot of money and time to earn enough interest from a 3% GIC to provide adequate retirement income. Also, GICs don’t index for inflation. Finally, in the aftermath of the recent market correction, the tsunami of money that has flooded into bonds issued by governments has pushed bond prices to risky levels. The first scent of inflation, or the ultimate lure of equity returns, will almost certainly cause bond prices to fall.

Once again, the advisor is faced with a difficult decision. This time the stakes are high, because the baby boomer retiree will have fewer and fewer options to replace any lost income or capital. The combination of historically low interest rates, the threat of creeping inflation, increased life expectancy, and a generation of retirees that has never experienced a reduction of lifestyle has produced a huge challenge for the professional financial advisor. Simultaneously, the baby boomers are traumatized by the recent market decline.

Enter the new, improved segregated fund with a guaranteed withdrawal benefit, combining with the most desirable features of an annuity with the advantages of a managed pool of income and capital appreciation assets. While I hesitate to suggest this choice for everyone, I do believe it meets the needs of some risk-averse clients. As long as interest rates languish at these low rates, a guarantee of 5% income appeals to many clients. I have used this choice for risk-averse clients if I think they would easily panic in difficult market conditions and withdraw their investment at exactly the wrong time.

Rather than expose them to this possibility, I have chosen a guaranteed withdrawal benefit segregated fund as part of a retirement income option. None of my guaranteed withdrawal benefit clients have cashed in their funds at the news of some real or imagined disaster. They receive their income, and we’ll revisit their situation as the triennial reset option comes due. They appreciate the guarantee of income provided by these funds.

  • Rod Tyler, CFP, R.F.P., CLU, is the founder of Tyler & Associates in Regina, Saskatchewan.