When you buy a RRSP at the age of 25, the financial industry is quick to point out that you are in it for the long haul and you can have a higher exposure to equities. On the other hand, if you are 55 and getting ready to retire in 5 years, you should adjust your portfolio by reducing the exposure to equities and adding more fixed income. I've written extensively as it applies to RRSPs and retirement. Here's a link to why you need to be more conservative the closer you get to retirement (a must read for retirees and near retirees).
Although it makes sense to people that the older you get the more conservative you should be, are people applying that theory to their education funds? I know many people who got caught in the market downturn from the world financial crisis of 2008. Their kids entered university and college and it was time to take out some funds but the portfolios dropped 20% or more. Then comes the dilemma of do you take the money out cause you need it or do you try to use other resources hoping the portfolio bounces back.
The problem with having too much equities the closer you get to retirement is the same problem as having too much equities the closer your child gets to post secondary education. My advice when it comes to investing the RESPs is the closer you get to pulling the money out, the more conservative you need to be.
Shorter time horizons with RESPs
In fact, the problem is compounded with RESPs because the total life of an RESP is shorter than the total life of RRSPs. With and RRSP, you might have money in an RRSP fro the day you start working to the day you die. That could be 50 or more years. With the RESP, the timelines are much shorter typically 15 to 25 years at the higher end.
RESPs should be more conservative than RRSPs
It is my feeling that RESPs should be invested more conservatively that RRSPs for a few reasons:
- The Canada Education Savings Grant gives you a 20% return off the start. Back when the CESG was introduced in 1998, a lot of people invested RESPs into technology funds because they were at the height of popularity only to find that a couple of years later when the tech bubble burst, many people lost the 20% government money and more. Many never recovered. If you had a guaranteed 20% return, is there a need to be overly greedy?
- Although the money technically belongs to the subscriber which is usually the parent or grandparent, parents usually invest the money with the intent of using it for their kids, specifically education. When I put money into the RESP, I think of it as my kids money, not my own. Because they are unable to make investment decisions, I feel it is my responsibility to manage that money with a certain degree of fiscal responsibility. In other words, do not feel it is prudent to speculate or take excessive risksAs mentioned earlier, time horizons are shortened especially once the child goes to post secondary education. It is typical that the funds are used up within 1 to 5 years. In fact there is no reason to leave any money behind so the intent should be to use the RESP fund up before the child finishes school. In the retirement world we talk about withdrawal rates where we want to take out enough to impact our daily cost of living but we also do not want to withdrawal too quickly. As a result, the withdrawal rate is highly linked to the investment decisions. With an RESP you are likely to have a very high withdrawal rate which means market downturn can have a devastating effect on the value of the RESP. I would argue that within 2 to 3 years of going to school, more than 50% of the RESP should be converted to cash and when the child goes to school all or most if the RESP should be in cash. Why take the risk?
My two cents
Personally I own a family RESP for my four boys whoa re all under the age of 7. Robbie is at earliest 10 years to post secondary education. I need to treat that as if he was 10 years or less to retirement and invest accordingly.
In Dec 2009, Larry MacDonald interviewed me about how I invest my RESPs. My strategy has not changed. I keep 50% in a conservative balanced fund and 50% in a bond fund. This has served me well for the past 7 years with all the volatility in the markets. Ideally, I would like less bonds and more GICs but that creates a need to have 2 accounts instead of one. We'll see if I pull the trigger and make that change.
In my last post, I featured RESP links in my Best of Blogs series. To get a more comprehesive list of articles on RESPs, check out Best of Blogs – Lost to know about RESPs.