Mike Holman had barely changed his son’s first diaper before he started to wonder how he was going put his boy through college or university. How was he going to afford it? How much would he need? How should this money be invested? A short time later, Holman opened an RESP and began looking for answers to those questions.
With the cost of education going up, many new parents turn to Registered Education Savings Plans early to maximize the amount of time they have to save for their kids’ schooling.
It’s a smart move, and as Holman discovered it makes sense to open one even if you don’t have extra cash to invest in the account. Money from birthdays and Christmas cheques from grandparents and other family members quickly add up, says Holman, a longtime investor who runs the Money Smarts blog and author of How To Withdraw Money From Your RESP Account Whether Your Child Goes To School or Not.
Government benefits like the Canada Education Savings Grant add up quickly too, which is one of the main benefits of an RESP. The CESG matches 20% of your annual RESP contributions up to a maximum of $7,200. There are other incentives as well. Ottawa, for instance, offers programs designed to help lower income families, while Alberta and Quebec each have their own incentives to residents in those provinces.
Today, Holman has a son and a daughter. And in the time it’s taken his kids to reach their fourth and fifth birthdays, he’s has been able to save $24,000 in their RESPs.
While setting up an RESP was no brainer for Holman, the hard part is deciding how to invest the money. Unlike RRSP which will have decades to grow, RESPs really only have only an 18-year time horizon. That shorter time frame can make the investing process confusing—should you try to grow the money, or should you aim to be as conservative as possible?
Peter Drake, vice-president of retirement and economic research at Fidelity Investments, says the key is to do both. If you start investing when your child is young, and you have 17 years before they need the money, then you can afford to be more aggressive, just as you would in your early years of an RRSP. The closer the child gets to his or her post-secondary education days, the more conservative you should be, he says.
That’s what Holman is planning to do. Since his kids are still more than a decade away starting from university, he’s comfortable putting all of the RESP money in to equities. “I’m not worried if the market tanks,” he says. “I have a long enough time horizon.”
Holman’s RESP asset allocation looks like this: 90% of the money is evenly split between Canadian, U.S. and European mutual funds and he put the last 10% into an Asian fund. He uses a similar allocation in his RRSP with the exception of a few bonds.
But the RESPs are fixed-income free—for now. As Holman’s children enter their teens he says he’ll start moving money into bonds. Eventually, he plans to end up with a 60% allocation to equities and a 40% exposure to bonds.
Less savvy investors may want to take a different approach. For those not comfortable managing their own investments Drake recommends buying a target date fund. Target funds are structured so that they adopt a more conservative asset mix of stocks and bonds over time, until the portfolio gets reaches a predetermined target date (typically 15, 20 or 25 years).
“The target date fund starts more aggressively but then rolls down automatically,” he says. “You’ll never completely get rid of equities, but the portfolio becomes more conservative.” Buying a balanced mutual fund, which holds about 50% stocks and 50% bonds, is another option he adds.
Still, Drake warns against being too conservative with RESPs, especially in the early years, because it’s hard to predict how much your kids will need. “You don’t know for sure what your kid is going to do,” he says. Drake has firsthand experience with this. He spent $10,000 a year to help one of his kids pursue a science degree and a $5,000 a year to put another through music school, but that amount soared to $100,000 when his child was accepted into a two-year music program in the U.S.
If you really don’t want to take any risk, Holman suggests putting the money in a GIC in an RESP account. You’ll still get the government grant, which is, ultimately, the reason why people use an RESP in the first place. “It’s cheap, safe and easy, and really you just need those grants,” he says.
Holman is satisfied with his more aggressive investment approach. All he needs now is more money to add to the account. Fortunately, the next birthday isn’t too far off.