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financial planning

There are few guarantees in life. So why do so many investors pay huge fees - or give up most of their growth - for what often turns out to be a worthless financial guarantee?

The first example is a long-term GIC investor. While there are often short-term reasons to be in a GIC, long-term GICs are rarely a good investment - and are an especially poor choice in periods of low interest rates. If long-term GICs are paying 8 per cent or more (higher than their long-term average of 7 per cent), then they can be a prudent investment, at least for tax-sheltered money.

I see that today I can get 3 per cent on a five-year GIC. This is among the worst five-year GIC rates in history. Now is the time to run far away from long-term GICs.

By contrast, a balanced portfolio of 40-per-cent bonds and 60-per-cent stocks has averaged a 9.8-per-cent annual return over the past 60 years, and if you picked the absolute worst 10-year period to invest in this portfolio (1999 to 2009), it still had an annualized return of 2.3 per cent before fees.

The biggest cost of long-term GICs - aside from being taxed at the worst rate if held outside a tax-sheltered account - is the opportunity cost. The long-term GIC is a no-fee product but it will cost you the most when it comes to returns.

The second example is a product like Manulife Income Plus or SunWise Elite Plus - known as a Guaranteed Minimum Withdrawal Benefit (GMWB). The guarantee portion is one of their key selling features. The problem is that the guarantee is essentially that over 10 years, the return will be 0 per cent or better. Keep in mind that a 3-per-cent annual return translates into 45-per-cent growth over 10 years compounded. So the 0-per-cent minimum guarantee is in itself only guaranteeing that after inflation and any taxes, you will only be somewhat behind inflation.

This guarantee might be worth something if it was guaranteeing a high-risk, high-reward investment. Unfortunately, these products don't let you invest in much beyond a balanced portfolio. That is fine, but when looking at 544 rolling 10-year periods since 1950, this type of portfolio has been below water exactly 0 times. While there is always a possibility you could lose out, 60 years of history has said the odds are extremely low. By charging 3.5 per cent to 4 per cent for these GMWB products each and every year, however, you certainly increase your odds of a 10-year loss.

On $100,000 over 30 years, an extra 1 per cent for the guarantee (assuming 5-per-cent return instead of 6-per-cent) would cost you about $142,000. Even paying a profession to manage your money, you could save at least 2 per cent a year in fees. That would work out to $329,000 in savings over 30 years on a $100,000 investment.

The point of all of this is that Canadians need to trust long periods of investment history. Don't pay high fees for guarantees that are almost worthless. You can find more intelligent ways to achieve investment peace of mind without restricting growth or wasting hundreds of thousands of dollars.