Common investing wisdom centres on minimizing the risk you must endure to achieve the results you need. Most of us inherently do not like uncertainty and volatility in our lives. We would much prefer to see a steady, predictable growth in our financial assets, and get our excitement elsewhere. If you have $1 million or more in liquid financial assets, you can probably base your investment strategy exclusively on this wisdom by investing it all in guaranteed term deposits and be just fine. Unfortunately, most of us are not in that position, and the world is not cooperating in helping us by becoming less volatile.

In essence, the problem is this: we need higher after-tax and after-inflation returns on our investments in order to reach our financial goals, but the risks we must undertake to seek those returns are paralyzing us. How do we cope with this dilemma?

We must look to time-tested strategies of diversification within and between asset classes, but also to alternative investment approaches.

Segregated funds

Most discussions of segregated funds begin by describing in technical terms what they are and how they work from an administrative standpoint. I am not going to do that in this article. For now, it is sufficient to consider that this type of investment offers, among other benefits, a combination of security and opportunity that is ideally suited to resolving the current dilemmas we face, as described above.

If you look at the returns generated from investing in almost any major investment market from 1900 to 2003, it is quite clear that investing in equity markets over the long term is a winning strategy. If you look over the period 1950 to 2003, it is equally clear. If you look at each decade individually since 1950, each and every decade saw significant growth. Only when you look at periods shorter than 10 years does the volatility become very clear and appear dangerous to your financial health.

Suppose you could invest in such a way that you could make volatility work for you instead of against you, and you could do so without risking your capital? In fact, you can do this by investing in segregated funds. Segregated funds mimic the results of the underlying mutual funds on which they are based. They can provide a guaranteed return of all or part of your capital if held to maturity, and they generally include a death benefit equal to the higher of the invested amount or market value. These features tackle the “security” part of the dilemma. This is significant but, in my view, not the most attractive feature of these instruments. Their most attractive feature for coping with the unknown but undoubtedly volatile future lies in the ability to lock in any market gains achieved at points over the 10-year horizon. If markets spike up by, say, 30% at some point, you can lock in that gain, which then becomes your new, guaranteed minimum. If markets later go down, your return is locked in. If markets go up again, you can again reset to the new higher level. This “ratcheting up” strategy provides the security you need to avoid trying to “time” markets by reallocating funds to safer investments every time there is a market scare, and it keeps you invested, so that major upward moves, no matter how short in duration, are not missed. Segregated funds purchased outside of registered plans may also offer certain advantages in estate planning and protection from creditors.

If this sounds attractive to you, make an appointment to see your Fraser Financial Group advisor now, while markets are still beaten up by the Iraqi war crisis and before any significant rally gets underway.

Caution: There are many different segregated fund programs with substantially different attributes, levels of guarantee, rules, and underlying investments. Some programs now offer many brand-name mutual funds and the ability to switch between them without affecting guarantees. Not all segregated funds include reset options, as discussed in this article. Consult your advisor.