Q. Several years ago, an advisor recommended I hold a Canadian dividend ETF in an RESP for my son. Would this still be a good approach for someone just starting an RESP for their baby, or is there a better alternative, given the increasing number of ETF options?
– Pete in Halifax
A. In many ways, RESPs are fundamentally different from retirement accounts such as RRSPs. They typically have a shorter time horizon, and they are usually depleted within four or five years, once your child reaches post-secondary school. In general, they are also much smaller than retirement accounts, since the most you can contribute is $50,000. But the same principles of risk management apply, and holding nothing more than a Canadian dividend ETF in an education account doesn’t provide enough diversification.
READ: What is an RESP?
If you’re opening a new RESP for a baby, then you have at least 18 years before you need to start withdrawing the money. So you should start with the goal of building a globally diversified portfolio, which includes all asset classes, not just Canadian dividend stocks. But the challenge—at least until recently— is that it can be difficult to build an efficient ETF portfolio when you only have a small amount to invest. To get the maximum RESP grant, you only need to contribute $2,500 annually, so the account is likely to be very small in the beginning.
The good news is that Canada’s largest ETF providers—Vanguard, iShares, and BMO—have all recently launched so-called “asset allocation ETFs” that provide one-stop shopping. Each of these ETFs includes six or more underlying funds that hold bonds and stocks from around the world, allowing you to build a globally diversified portfolio with just a single trade. If you want to use ETFs in an RESP, these funds are ideal.
While your child is very young, you can afford a relatively aggressive approach, as long as you are comfortable with the volatility. For example, the Vanguard Growth ETF Portfolio (VGRO) holds 80% stocks and 20% fixed income and could be a suitable holding for the first 10 or so years. If you would prefer something less volatile, all three ETF providers offer a balanced version with 60% stocks and 40% bonds.
Once your child gets close to high school age, it makes sense to dial back the risk significantly, since you want to be sure that a bear market won’t jeopardize your child’s education funding. That will likely mean gradually selling shares of the ETF in putting the proceeds in cash or fixed income (such as short-term GICs), to make sure the money is available when it’s time to pay the tuition bills.
Dan Bortolotti, CFP, CIM, is a portfolio manager and financial planner with PWL Capital in Toronto.
MORE BY DAN BORTOLOTTI:
- The best TFSA investment for a time horizon of 3 to 5 years
- An advisor is charging 1.95% for an ETF portfolio. That’s too high.
- What to look for when choosing a financial advisor
- Why GICs deserve a place in any fixed income portfolio