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Investing for your child's education is more sprint than marathon. That's because, unlike retirement, the finish line comes a lot sooner.
"You know your child will need the money at about age 18 with RESPs, but with RRSPs, you may not need the money for several decades," says Sajjad Hussain, private wealth counsellor with Fiduciary Trust Canada, in Toronto.
Yet parents do not need to put all their RESP contributions into government bond funds or other low-yield, low-risk investments. Investing in equities is still important, as long as one starts saving early enough.
"For a newborn to the age of five, you could actually go with 100 per cent equities," Mr. Hussain says. As a child moves closer to college, however, the portfolio should become increasingly conservative, investing in bonds, GICs and high-interest savings accounts.
Although the returns are low, even flat when factoring in inflation, capital preservation becomes increasingly important, says Robert Armstrong, the Toronto-based head of managed solutions with Bank of Montreal Global Asset Management.
"There's a point where you have to stop trying to grow those assets and protect the capital, because you will not have the time to make up any potential losses that the market may give you," Mr. Armstrong says.
Furthermore, RESP investors have less need to take on the higher risk and return offered by equity markets because their contributions already receive a de facto 20-per-cent return thanks to the Canada Education Savings Grant, he says.
"The No. 1 thing with your RESP strategy is to maximize the grant money," Mr. Armstrong says.
The grant is worth as much as $500 a year on contributions up to $2,500, though additional grants may apply for low-income families. With a lifetime grant maximum of $7,200 per child, it takes more than 14 years of contributions to earn the full benefit.
Although you can make up for missed years, doubling up payments annually to earn double the grant, what can't be made up is lost time. The sooner the contribution is made, the more time the money can grow tax-sheltered.
Yet because of the relatively small amount of money inside an RESP at the outset, Mr. Armstrong says investors likely are best served by investing in mutual funds, which offer relatively low-cost diversification, using an automatic preauthorized contributions strategy.
"This strategy allows for easy dollar-cost-averaging, so you don't have to pay attention to it on a regular basis," he says.
With mutual funds parents can also make small contributions, say $25 a week. Trading commissions can add up when making small purchases of individual stocks and even exchange traded funds (ETFs).
As investors accumulate money in their accounts, those who are concerned about the high management costs of mutual funds can consider purchasing low-fee ETFs and even individual securities, Mr. Armstrong says.
In the meantime, many fund companies offer low-cost options, including index funds that track the performance of a benchmark such as the TSX Composite Index, says Mike Holman, the Toronto-based author of The RESP Book.
"Typically in Canada with actively managed equity mutual funds, you're looking at two per cent in management costs or higher per year, but an index product costs just a fraction of that amount," Mr. Holman says. "Even if you believe in active management, it's hard to make up that difference in management cost over the long haul."
More sophisticated investors who want additional control over their portfolios can choose ETFs instead, which have costs that are even lower than index fund MERs.
Some discount brokerages also offer commission-free ETF trades, but investors who have to pay commissions can reduce their impact by allowing contributions to accumulate – to about $1,000, for example – before they make a trade.
The same advice holds true for investors who want to purchase individual stocks – a viable option for people who are willing to do the homework, Mr. Armstrong says. When buying stocks, however, he suggests sticking to large companies that pay a steady, rising dividend.
"If people are comfortable investing on their own, Canadian blue chip companies are a great alternative," he says. "You just have to remember to scale back the risk over time by adding fixed income securities."
Once investors start adding fixed income, however, they should not buy individual bonds because the relatively small amount of money in an RESP does not allow for large enough purchases of bonds to build a diversified and cost-efficient fixed-income allocation in the portfolio, Mr. Hussain says.
For this reason, bond mutual funds and ETFs are better options.
Typically, the bond component should be oriented toward Canadian and provincial government bonds. While low-yielding, they are also low-risk – and that's the point, Mr. Hussain says.
"You want bonds to appreciate and have some yield, but you want that bond exposure primarily to reduce volatility and preserve wealth," he says.
More sophisticated investors can go beyond Canada's borders for higher yields, but foreign bond investments also have currency risk, so a rising Canadian dollar could mute the additional yield, and even incur losses.
Over all, however, most RESP investors are better off avoiding complexity, Mr. Holman says.
"In a lot of cases, parents have got a new baby to look after so they just want to cross it off the 'to-do' list," he says. "For them, the main thing is to keep it simple and easy."
Investing on auto-pilot
Target-date portfolios are a good option for investors putting money into registered education savings plans. These portfolios offer a little more return, risk and complexity than guaranteed investment certificates (GICs), without the concern of having to manage the investments.
An RESP target-date offering is a portfolio of mutual funds that automatically reduces market risk as a child moves closer to enrolling in postsecondary school.
Early on, the portfolio is invested in mostly equity mutual funds. Fixed-income holdings are added slowly over the years to reduce risk. By the time your child enters postsecondary school, the funds are largely invested in liquid money-market funds.
So far, only Royal Bank of Canada and the Bank of Montreal offer RESP target funds. The RBC offering starts out with management costs of about 2 per cent, decreasing over time as the fixed-income holding increases.