Your Complete Guide to Index Investing with Dan Bortolotti

Taking Risk in an RESP

2018-06-17T20:22:30+00:00November 5th, 2010|Categories: Portfolio Management|Tags: , |160 Comments

My recent column in MoneySense offers suggestions for parents who want to use the Couch Potato strategy in a Registered Education Savings Plan (RESP).

Investing in an RESP presents some added challenges compared with a retirement account. First, the time horizon is usually shorter: even if you start contributing to an RESP when your child is born (and most parents don’t), you’ll start tapping the funds in no more than 18 years.

The account size is also much smaller. You’re not allowed to contribute more than $50,000 to an RESP, and most parents won’t ever hit that maximum. If your RRSP account isn’t that large now, we’re hoping it will be before you’re ready to retire.

For these reasons, I suggest that RESP investors use index funds rather than ETFs: something simple like the Global Couch Potato (assembled with TD e-Series funds) is all the diversification you need. That advice is echoed by Mike Holman, Money Smarts blogger and author of The RESP Book, whom I interviewed for the column.

There is one other idea in the article that I’d like to expand on. As your child approaches university age, it’s important to gradually decrease the risk in her RESP. You can invest in stocks when she’s a toddler, but by the time your child is 18, all of your RESP money should be in fixed income (short-term bonds, GICs or cash), so you’re certain it will be there when you need it. Imagine if your teen was getting ready for Frosh Week in September 2008 and her education savings were in an all-equity fund. You could have lost half of your RESP and put your kid’s university plans in jeopardy.

Adjusting your RESP asset allocation

Here’s my strategy for dialing down the risk in an RESP. Until your child is nine years old, you can keep as much of her RESP in equities as you want. For example, Mike Holman’s children are two and four years old, so his RESPs are 100% stocks for now.

After that, consider this formula: Subtract your child’s age from 18, then multiply by 10. That’s the maximum percentage of an RESP that should be in equities. My 13-year-old’s account is split 50-50, while my 16-year-old’s is only about 20% stocks. Here’s a year-by-year breakdown:

Your child’s age Maximum % equities
Minimum % fixed income
8 or younger 100% 0%
9 90% 10%
10 80% 20%
11 70% 30%
12 60% 40%
13 50% 50%
14 40% 60%
15 30% 70%
16 20% 80%
17 10% 90%
18 or older 0% 100%

I stress that these are maximum stock allocations. Depending how early you start and how much you’re able to save, you may not need to take much equity risk at all. Thanks to the generous 20% government grant on RESP contributions, $200 a month starting when your child is six will grow to $50,000 by the time she’s 18 if you earn a modest 5% annually.

160 Comments

  1. Simon February 1, 2018 at 3:51 pm

    Hi Dan,

    With the release of Vanguard’s “ETF Portfolio”‘s ETFs, I was wondering if it made sense in an RESP to just buy those (or Blackrock’s equivalent) and switch the ETF as time goes by.

    As an example, buy VGRO from 0 to 8, VBAL from 9 to 13 and VCNS from 14 to 16. After that, either go for cash or short-term GICs.

    The allocation might not be optimal but, to me, the convenience and ease of adding more money make a lot of sense. Am I missing something here?

    Thanks

  2. Canadian Couch Potato February 2, 2018 at 7:38 am

    @Simon: That seems like reasonable strategy. If you’re adding new money to the RESP more than one or twice a year, however, just make sure you’re not paying too many trading commissions.

  3. Calli March 20, 2018 at 9:08 am

    We have a 5 and 3-year-old and I have opened up a self-directed RESP account with TD that I plan to put $100 per pay into.

    I have read a lot about the TD eSeries funds and they are highly recommended for their low maintenance cost and the ability to buy without commissions. I can also have any deposits automatically dispersed to a set of them by predetermined % breakdown.

    Or do I look at ETFs, however, I worry that I could be missing out on gains if I am only depositing when I have sufficient cash to do so. Meaning that I would wait for 5-10 pays then drop $500-$1000 at a time so I am not paying a commission every time.

    So, my question is if the eSeries MER is low enough are they a good option for this account? Or will I gain more from an ETF that the commission won’t be that much of a factor?

    Thank you,

  4. Canadian Couch Potato March 20, 2018 at 9:26 pm

    @Calli: Based on what you’ve written, I really don’t think you will be “missing out on gains” by using the e-Series funds rather than ETFs. The difference in MER between the two options is about 0.20%, or $20 a year on every $10,000 invested. Put that way, I think you will agree that it’s not worth it, especially if the monthly contributions are working for you.

  5. Heather April 10, 2018 at 9:24 am

    How do I decrease the risk in my investment if I have a family RESP? My kids are 9 and 6 so I’m not eager to move 10% to fixed income yet. What would you recommend doing?

  6. Canadian Couch Potato April 10, 2018 at 10:08 am

    @Heather: Trying to set a target asset mix for two children in a family RESP is likely to be confusing and not worth overthinking. In general, I would err on the side of being more conservative (that is, base the asset mix on the oldest child). As for how to decrease risk, there is really no alternative other than moving to more fixed income.

  7. Sharon April 30, 2018 at 2:04 am

    My child is turning 16 this year and the RESP is currently all in mutual funds. The return is showing at 16% and the MER for some of the funds can be as high as 2.7%. Do you still recommend to turn them all into index funds or ETF until he needs the money in the next 2-3 years this late in the game?

  8. Canadian Couch Potato April 30, 2018 at 8:08 pm

    @Sharon: In the couple of years before a student enters college or university, it’s time to move the RESP into super-safe investments (cash and short-term GICs). Your goal at this point is making 100% sure the money is there to pay for his or education, not to earn high returns.

  9. JP June 17, 2018 at 7:33 pm

    Hi Dan, what do you think of using a Robo advisor trading etfs for an RESP? You can usually change the risk level for free? The reason I’m asking is just to avoid one more place to go for my finances with the TD fund. Trying to get progressively closer to a one stop shop as I’m already into questrade and wealth simple. I could also build my own with QT but I see how aggressively rebalancing every year to reduce risk could end up costing me a bit and is against your advise. Also I’m more of a Lump Sump payment once or twice a year type. Thanks! JP

  10. Canadian Couch Potato June 17, 2018 at 9:45 pm

    @JP: Sure, a robo-advisor can be a good option for RESPs, at least when your children are young. One thing I would consider, however, is that RESPs should generally be in cash and GICs once you get close to the withdrawal stage. Robo-advisors don’t offer that option.

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