Registered education savings plans (RESPs) are a no-brainer for Canadians who are saving for their children’s post-secondary education because of the tax-free withdrawals and the federal government’s matching of contributions. But deciding what to invest in for an RESP is a trickier task. Those decisions become even more complicated as the beneficiary advances from being a young child to a post-secondary student.
When a client’s child is in primary and middle school, the main objective should be on making investing choices that maximize returns in an RESP because the money won’t be needed for a long time, says Kash Pashootan, chief executive and chief investment officer at First Avenue Investment Counsel Inc. in Toronto.
Adrian Mastracci, senior portfolio manager at Lycos Asset Management Inc. in Vancouver, shares that sentiment. “The primary mission at this point is to grow the account, not capital preservation.”
Equities have provided the highest long-term rates of return, historically, even though their value can fluctuate significantly in the short-term, Mr. Pashootan notes. So, investing in equities via stocks, equities-focused mutual funds and exchange-traded funds (ETFs) is a good choice for a younger child’s RESP because they provide the greatest opportunity for long-term growth. However, he has one caveat: “Never compromise quality when investing. Even with a long time horizon, speculating when investing is not suitable.”
Mr. Pashootan says that a mix of 80 per cent equities and 20 per cent fixed-income for an RESP at this stage of a child’s life is ideal. Similarly, Mr. Mastracci says the initial RESP asset mix could easily be as high as 100 per cent equities because the assets will not be required for a long time. His preference is an asset mix ranging between 80 per cent and 100 per cent equities.
For the equities component, Mr. Pashootan recommends dividend-paying companies in North America – but not necessarily household names such as banks and utilities. Given the relatively long time horizon, focusing on growth-oriented, dividend-paying equities is more appropriate. He points to Best Buy Co. Inc. (BBY-N) as a good example because of its impressive transition from a bricks-and-mortar retailer into a powerful online retailer and its track record of raising its dividend at an average of 13 per cent a year for the past decade.
Mr. Mastracci takes a broader approach and suggests that initial equities targets may be 25 per cent allocated to Canada, 30 per cent to the United States, 15 per cent globally and 10 per cent to emerging markets. The fixed-income component may include guaranteed investment certificates (GICs). He prefers starting with ETFs because one or two of these products will fulfill the desired mix and rebalance the assets periodically.
As clients’ children get older and the date upon which the education funds will be withdrawn approaches, RESP investments should be shifted gradually to those that have less short-term volatility, namely fixed-income assets such as bonds, GICs and money market funds, Mr. Pashootan suggests.
This strategy helps to reduce downward swings in value and ensures the money will be there when it’s needed. He suggests that when a child turns 16 years of age, at least 20 per cent of the RESP should be in cash or GICs and no more than a 40 per cent allocated to equities. Even then, he recommends shifting to “boring” dividend-paying names, such as the Canadian banks and utility companies such as Emera Inc. (EMA-T).
“Many people forget, especially after a decade of fruitful equities markets, that even the highest-quality dividend-paying companies can have their share price decline in the short-term,” Mr. Pashootan says. “[These declines are] not a concern if [clients and their children] have the years to let equities take their course, but rather problematic if the capital is required for paying tuition.”
In Mr. Mastracci’s view, the investments within an RESP should begin to be transferred to short-term cash instruments from equities about three years before the student begins withdrawing the assets to pay for post-secondary school. He recommends a three-year ladder of fixed-income selections, such as GICs, starting when the student is aged 15 or 16.
Once a client’s child is enrolled in an eligible post-secondary institution, the assets in an RESP will begin to be withdrawn. Mr. Pashootan says that exposure to volatility will need to be minimized because of the RESP’s very short-term time horizon. Thus, he suggests clients avoid any investment in equities and stick to very stable and short-term cash and fixed-income securities such as savings accounts, GICs and high-quality short-term bonds.
Although it may seem counterintuitive to retreat from the stock market, he says that “you can’t have your cake and eat it too.” The benefit of earning a few extra percentage points from being invested in equities is far outweighed by the risks that the capital would decline significantly in value when the child needs it to pay for school.