My brother recently had a baby and we have been discussing what type of investments he should have for his RESP. There is literally an 18 year timeframe for the investments to grow before you start withdrawing. He had a look at my current holdings for my kids RESP and noticed it was all high paying dividend stocks with minimum growth potential.
What I have in my RESP portfolio are the results of a late switch out of mutual funds and 12 years of investing in it. I have to admit that I have not been able to maximize my contributions all the time. As much as I wanted to contribute, I did not prioritize RESP over RRSP for the simple reason that RESP is not the only way to fund a school education.
There are many points around RESP that you will need to get familiar with but the main RESP facts to get you started are the following.
- Maximum of $2,500 contribution annually per child for the 20% grant. If you put more than $2,500, you won’t get extra money from the government.
- Somewhat limited investing horizon with 18 years. You basically assume that you will have to start withdrawing money once your child finish high school and enrols into a university or post-secondary education.
- Your portfolio grows tax free!
Your goals are to maximize the government’s contribution and make the account grow to cover at least 4 years of university. How much do you need? It all depends on your choice of post-secondary education and where the student is going to live.
Just like retirement, you want to know how much you are going to need. A ballpark figure is fine and if you can generate a larger portfolio obviously. I have written a post on determining how much retirement might cost you along with how much you may need. In case you have a pension plan and your payments are all figured out, planning your RESP will require some work.
Below are the 2 scenarios for a post-secondary student you need to consider above and beyond having food and clothes.
Live @ Home
- Tuition Fees
Live Out of Town
- Tuition Fees
Estimating Tuition Fees
To estimate tuition fees, you need to take an average of a few post secondary institutions around you. Make sure you take all the spending into account. If you want to estimate down the road, throw an inflation value on it and adjust the numbers as your child grows up. If that’s too much work, do it every 5 years to start with.
Tuition fees at UBC for one year cost around $6000 (rounded up) for the year plus $1,500 in books (average). See the UBC site for tuitions details. Some programs cost more and up to $10,000 for one year and often times fees go up after the first year.
Transportation is location dependent but a student transit pass in BC for post secondary student is $40 (rounded up) per month. Assuming you do 2 terms per year, you spend $320 for commuting. A vehicle is a very different story as you need to include insurance, gas, and maintenance.
RESP Risk Roadmap
Unlike a RRSP where you would never want to use it all up unless you had other source of income, the RESP can be completely depleted by the end of school. If you have more than one child on a family plan, you need to account for the other child as well 🙂 Managing risks is managing the type of investments you hold. The higher risks, the higher the potential for return and vice versa. Side note: The Investor’s Manifesto is a great book to educate on the risks of the stock markets.
I like to start by dividing the roadmap in 4 since it makes it easy to get started.
- First 4.5 years : You want to maximize growth
- Second 4.5 years : You want to start shifting a percentage to fixed income
- Third 4.5 years : You want to adjust the percentage to more fixed income
- Fourth 4.5 years : You want most of it in fixed income
That’s the premiss of capital preservation. The type of investment to use is where it all gets complicated. My RESP account never really performed early on as I had poor investments (and lacklustre advice). Once I switched my RESP over to my dividend portfolio, I did not want to add risk and I wanted to focus on income. My RESP account is set now and aside from the REITS having lost some value, it all DRIPs monthly 1 or 2 shares for each investment.
It’s important you define the risk roadmap you want as it will inform you of the type of investments to look for.
RESP Investment Roadmap
The initial challenge is that you are not adding a lot of money to buy equities and you cannot diversify much. In the first year, you could have 3 investments at $1,000 each. It’s possible if equities are what you want and you can still make monthly contributions by just leaving them in cash until you have $1,000 for example. Your trading cost if your fees are $9.95 per trade amounts to 1%.
Buying ETFs allow you to diversify faster across markets. You can look at applying an index investing strategy early on. ETFs trade like stocks though, so you would have the same trading cost unless your discount broker offer free ETFs. Questrade has free ETFs so if you have taken benefit of the Questrade promotions, you are in luck. You can buy your favorite dividend ETFs with every contributions and benefit from dollar cost averaging.
You can also buy mutual funds but you need to be very selective of what you buy and understand the fees you may potentially pay (front-end or back-end). I am not a big fan of mutual funds.
Now comes the hard work of actually deciding on what to buy. What I suggested my brother do was to do a mix of index investing for US investments and then buy equities for CDN investments in companies he wishes to buy. For the fixed income portion, he can add bonds. Do your own research and define a plan according to your risk appetite. As it happens, he knows how to buy bonds and it’s part of my goal this year to add bonds. I am just unsure if I buy a bond or a bond index. The case for buying an US index is to make sure you have exposure to the biggest market in the world without the tax complication of owning a dividend stock in this account since dividends are taxed.
When it comes to my RESP, I have two goals over the coming years:
- Add bonds to it in the form of an index or just a bond (which needs a minimum of $5K)
- Add a US index ETF
RESP Planning Summary
Like any new parents, a new and exciting chapter is about to start. You are ready to put money aside for the future of your child and benefit from the government contributions. Just like your life, you need a plan and it starts with planning your investments. In my future RESP posts, I will go over contributions and the tracking you need to do to plan withdrawal in the future, otherwise you may very well run into trouble.