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You may have heard the pitch for popular market-linked GICs: If stock markets go up, you win by sharing in the wealth; if they go down, you don't lose because your initial investment is guaranteed. Marketers, reasoning that investors are moved by fear and greed, are appealing to both emotions.

But these and other seemingly no-lose investments come with hidden costs that undermine their effectiveness. People who buy them pay dearly to protect against a potential stock market drop they could likely weather by having a properly balanced portfolio, says Warren MacKenzie, founder of Weigh House Investor Services in Toronto, now part of HighView Financial Group.

"In a well-structured and diversified portfolio, there is a very low risk of losing everything," Mr. MacKenzie said in an interview. "Investors need to weigh the real cost of investment guarantees."

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To bolster his argument, Mr. MacKenzie offers a study prepared by HighView, of which he is a principal. It shows how four separate portfolios would have performed in the 2008 stock market panic – the worst in recent memory – and how long they took to recover.

A well-balanced portfolio with 40 per cent stocks fell 9.7 per cent over three calendar quarters and took an additional two quarters to recover. A portfolio with 25 per cent stocks fell just 3.7 per cent and also took two quarters to recover. The point is that a well-balanced portfolio with a greater proportion of stocks fell more than the one with fewer stocks, but recovered just as quickly, he says.

"One was down six points more, but over a 10-year period it made about 25 per cent more," Mr. MacKenzie says. For the 10-year period ended Dec. 31, 2013, the portfolio with 40 per cent equities provided a compound annualized return of 6 per cent, while the more conservative one returned 4.8 per cent, the study shows.

"If one understands what the likely downside is, what the recovery period is, and how much you would gain if you could live through that compared to the outrageous cost of guarantees, I think most people would prefer a diversified portfolio," he says.

The study was based on quarterly returns net of management and advisory fees. Highs and lows would have been more extreme if HighView had used daily, weekly or monthly returns, the firm notes. The hypothetical portfolios comprised a handful of actively managed funds and ETFs.

Indeed, guaranteed products such as market-linked GICs may soothe nervous investors but at a price, says Kurt Rosentreter, a senior investment adviser at Manulife Securities in Toronto. The list of negatives is long, he adds. With many of these products, investors are locked in for several years. "If your situation changes, you lose your job and want your money back, you can't get it," he says.

In addition, returns are often taxed as interest income rather than dividends or capital gains, which benefit from a lower tax rate. "They're tax-unfriendly for non-registered savings," he adds.

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While index-linked notes and GICs track a basket of securities, you only get part of the gain, he notes. As well, the gain may not be calculated until the day before the product matures. So while markets may have soared during the GIC's term, your anticipated profits could be wiped out in the final hours.

Finally, buyers of these securities usually don't get the dividends they pay because the financial institution keeps them as part of its fee, he says.

"People who buy them say they sounded like a good idea," Mr. Rosentreter says. "But they really have never stopped to peel the orange to see what they are getting."

Like Mr. MacKenzie, Mr. Rosentreter believes index-linked GICs are unnecessary. Investors can get the benefits of guaranteed products without their high costs, he says. They need only buy a strip bond – a bond with the interest coupon stripped away – and a broadly based stock market exchange traded fund (ETF). Strip bonds, which constitute the principal part of the bond, offer a guaranteed return because they are bought at a discount and redeemed at face value.

The cost of investment guarantees depends on the product, Mr. MacKenzie says. Embedded costs could come in the form of a higher management fee, a cap on potential stock market returns or a structure designed to protect the guarantor, "with features to benefit investors a secondary consideration," he says.

Financial institutions wouldn't offer a guaranteed product unless they were sure of their ability to make money from it. "And if they are that sure of doing well, then it's unlikely to be a good idea to be on the other side of their trade, so to speak," he says.

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Segregated funds – mutual funds packaged with an insurance policy – also bear crippling fees, the advisers say. "You're probably looking at 3 per cent," Mr. Mackenzie says. In a period of weak stock markets, such high fees can really hurt investors.

Fees for segregated funds range from 2.5 per cent to 4.5 per cent a year, Mr. Rosentreter of Manulife says.

Over the next decade, investors in a balanced portfolio of half stocks and half bonds might make a total return of 4.5 per cent a year, Mr. MacKenzie says. "After taking off these high fees, you're looking at a (net) return of next to nothing."

While segregated funds may offer some degree of creditor protection in most provinces, another oft-touted advantage is that they are not subject to probate fees. This feature is less advantageous than it may appear, Mr. Rosentreter says. Probate fees vary from province to province, but in Ontario, for example, they are 1.5 per cent.

A 50-year-old investor could well end up paying the higher management expense ratio on segregated funds for the next 40 years.

"You pay a higher embedded cost every year you live to save 1.5 per cent the day you die," Mr. Rosentreter says. "That's triple what you could otherwise pay for professional money management."

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