How Do Segregated Funds Differ From Mutual Funds?

Mutual funds are investment vehicles that many investors have embraced as a simple and relatively inexpensive method for investing in a variety of assets. Over time, mutual funds have become one of the most popular investment tools that allow for diversification by following a specific exchange, with options for both passive and active management. Meanwhile, segregated funds are similar to mutual funds as they have an investment component, but they possess some key differences as well.

Similarities Between the Funds

On the surface, both investment vehicles represent a collective pool of funds that investors pay into. After doing so, typically another party makes the decisions regarding asset allocation and other investment-related choices. Furthermore, all financial assets within each fund are still owned by the organization that is managing the pool of investments, while investors own interest on the assets.

Differences Between the Funds

However, this is more or less where the similarities end. Segregated funds are considered to be life insurance products sold by insurance companies and, as a result, the governing bodies and regulations responsible for overseeing segregated funds are usually the same ones that cover insurance companies.

Another fundamental difference between segregated funds and mutual funds is that segregated funds generally offer a degree of protection against investment losses. For example, most segregated funds will guarantee around 75-100% of premiums paid (minus management and other related costs) in the event of maturity or the policy holder's death. This differs from mutual funds because, in the unlikely event that all of the underlying stocks that make up a mutual fund become worthless, investors stand to lose all of their invested assets.

Segregated funds also have some other benefits relating to the death benefit portion of their policies, since they double as life insurance policies. Beneficiaries of the policy will usually directly receive the greater of the guarantee death benefit or the market value of the fund holder's share.

These funds can also be withdrawn from throughout the contract, but the guarantees—the benefit payouts—are reduced proportionally.

With a mutual fund, on the other hand, the market value of the asset is subject to the same estate-related processes that other assets go through, which means it may take some time before any parties receive a payout. Mutual funds are also typically held as longer-term investments, but there is no contract in the same way that segregated funds maintain. Geographically speaking, segregated funds also tend to be more popular in Canada whereas mutual funds dominate in the U.S. market.

Despite their advantages, segregated funds are not without drawbacks. Some segregated fund fees are higher than those of mutual funds because they require more management. How much you pay in management fees depends on the fund you choose. For instance, the RBC U.S. Equity GIF has four series you can choose from, each with its own expense ratio ranging from 1.89% to 3.16%. You'll also find different types of sales charges within these funds if you sell within a certain number of years, depending on the type of option.

In comparison, the Fidelity Large Cap Core Enhanced Index Fund (FLCEX) has an expense ratio of 0.39%. The fees you pay for withdrawing from your mutual fund depend upon the fee table and how long you have had the funds invested, but they are still generally much lower.

Correction—April 30, 2022: This article previously explained some fund terms and fee structures incorrectly.