Smart RESP investing takes burden off children
My 10-year-old granddaughter went blissfully off to Grade 5 on Tuesday, oblivious to the fact she has more money than she can possibly imagine. But even if she knew about it, she wouldn’t really care. She can’t touch it or spend it; so as far as her daily life is concerned it doesn’t exist.
But in a few years, the registered education savings plan (RESP) that her parents opened for her and her brother when they were just babies will become one of the most important elements in her life. The money in the plan will enable both children to go on to college or university without having to incur the huge debts that encumber so many students for years after graduation.
Her parents aren’t rich, but they were willing to make the financial sacrifices necessary to set up a family RESP when the kids were young. In doing so, they were able to maximize the government support that is a key part of these plans: a grant of 20 per cent of the contribution up to $500 a year, to a lifetime maximum of $7,200. (Additional money is available to lower-income families: see the RESP section of the website of the Canada Revenue Agency for more details.)
But government support is just part of the equation. Building a sizable RESP also requires making wise investment decisions, since all the income earned within the plan is tax-sheltered. Simply leaving the money in a savings account or putting it in a GIC at 1.5 per cent interest isn’t going to generate much of a college fund. I suggest opening a self-directed RESP with a brokerage firm and using mutual funds and/or ETFs to up the return potential.
Some careful management is needed and adjustments to the asset mix must be made periodically. During the early years, the portfolio should be growth-oriented with a relatively small fixed-income component. As the child approaches college age, the percentage of fixedincome assets should be increased to reduce the risk of loss in the event of a stock market crash. By the time the student has finished high school, almost all of the fund should be in fixed-income securities or cash.
Here is a sample portfolio for the first stage of a child’s life, from birth to age 10: High-interest savings account
It’s a good idea to keep a small amount of cash in reserve to be able to take advantage of opportunities, such as a stock market correction that creates some good bargains. Weighting: 5 per cent. Canadian stock mutual fund/ ETF
A fund with a strong track record that invests in top Canadian companies should be one of the foundations of this plan. Because of the relatively long time horizon, it doesn’t matter if it is a mutual fund or an exchange-traded fund. You’re looking for above-average returns with below-average risk. Some examples are Beutel Goodman Canadian Equity Fund, Fidelity Canadian Large Cap Fund and iShares S&P/TSX 60 Index ETF. Weighting: 30 per cent. U.S. stock mutual fund/ETF
The American stock market is much more broadly diversified than ours and is the strongest in the world. So a U.S. equity fund should boost this portfolio’s returns. Examples of funds with good longterm track records include Beutel Goodman American Equity Fund, iShares U.S. Fundamental Index ETF, Trimark U.S. Companies Fund and TD U.S. Blue Chip Equity Fund. Weighting: 30 per cent. International stock mutual fund/ETF
Add an international fund to this portfolio to provide exposure to the growing overseas markets. Some I like include Black Creek International Equity Fund, Mawer International Equity Fund and iShares Core MSCI EAFE IMI Index ETF. Weighting: 10 per cent. Universe bond mutual fund/ETF
All portfolios should have some fixed-income exposure, so use a universe bond fund or ETF to round out this one. Weighting: 25 per cent.
As the child gets older, the portfolio should become more conservative to protect against big losses. This can be done by gradually reducing the amount of stock market exposure, and increasing the bond and cash segments.
The closer the student gets to college age, the more important it becomes to emphasize safety and liquidity. Heavy losses are unacceptable at this stage as there is no time to recover. Most of the stock funds should be sold off as market condi- tions permit and the money redirected to fixed-income funds and high-interest savings.
Once the student is ready to start college, almost all the risk should be removed from the RESP. At this point, most of the assets should be in the high interest savings account and a short-term bond fund so that the money will be readily available as needed.
Ideally, there will be enough in the RESP to put all the kids through college without any of them having to resort to student loans. Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. His website is BuildingWealth.ca. Follow him on Twitter @GPUpdates.