In the last couple of weeks I’ve received two questions from readers who were trying to figure out the right strategy for their children’s education savings accounts. Both were smart questions that stemmed from things they had read on this blog, and I was eager to help. But as I thought about how to respond, I began to worry about the danger of making some investing goals too complicated.
The first question came from Karen, who had opened an RESP for her nine-year-old. Karen had read my post on bond duration, where I explained that investors should try to match the duration of their bond fund to their time horizon. She wondered if XBB (which has a duration of about seven years) would still be suitable once her child was 11 or 12. If not, what’s the best way to shorten your bonds’ duration as your child approaches university age?
The second came from Bryan, who has an RESP for his five-year-old and a second child on the way. His brokerage, TD Waterhouse, allows only family RESPs, which means he can only open a single account for both children. Bryan read my post about choosing an appropriate asset allocation for an RESP according to your child’s age and wanted to know how it would work when you had two beneficiaries of different ages.
In both cases, it’s possible to create a spreadsheet and a formula to work out the optimal strategy. But the question is, how far do you want to go with this?
Can’t get no satisficing
More than half a century ago, the psychologist and economist Herbert A. Simon coined the term “satisficing” to describe the process of making a decision that is good enough, as opposed to “maximizing,” which seeks the perfect solution. When it comes to RESPs—and other investing goals, for that matter—I think it often pays to be a satisficer.
Remember that RESPs are medium-term investments: even if you open an account when your child is an infant (and most parents do not) you are not likely to have more than 18 years before you start drawing it down. It may be fairly large by that time (although I would argue it makes little sense to contribute more than $36,000, at which point the government grant is maxed out), but by that time virtually all of it should be in cash, GICs, or other safe, low-return instruments. A significant percentage of your RESP may be in equities when your child is young, but that is when the account will be smallest, so your rate of return is not likely to have a large effect during these early years. And, of course, a significant portion of the growth in RESPs is likely to come from the 20% government grant.
All of these factors mean the amount you contribute to an RESP will typically have a far greater impact than your investment returns. Here’s an example: if you contribute $167 a month beginning the year your child is born and ending the year she turns 18, you’ll collect the maximum grant ($7,200) and wind up with about $56,200 assuming an annualized return of just 3%. If you contribute $100 a month, you would need a return of about 8.5% to end up with the same amount. So are you better off trying to come up with an extra $67 a month, or trying to triple your investment returns?
Simple isn’t settling
To return to the readers’ questions, I would suggest Karen use XBB for her bond holdings now. Starting when her child is 11 or 12, she can gradually move some of the money to cash until the proportion reaches 80% to 100% by the time her child starts university. For Bryan, I would just opt for an allocation that is close to what one might use for the oldest child—even a straightforward 50% equity, 50% fixed-income blend would be fine until the oldest reaches high school, after which I would start dialing down the risk. But there are several other strategies that would work just as well—and none of them require a spreadsheet with complicated formulas.
Karen and Bryan were asking the right questions, and I certainly don’t mean to suggest that investors shouldn’t care about the details of their strategy. Indeed, one of the frequently misunderstood ideas about “satisficers” is that they have low standards and are happy to settle for mediocrity, which just isn’t true. My point is simply that it’s possible to adopt an RESP strategy that is low-cost, broadly diversified, easy to implement, and fully capable of meeting your goal, even if it is less than optimal. More important, there is a lot of evidence that satisficers tend to be more content, less paralyzed during the decision-making process, and less likely to be plagued by regret—and those qualities are almost certain to make you a better investor.