Education investing: what’s best?
Most parents and grandparents know that in the world of the 21st century, higher education will be the key to their children’s success.
And they worry about it. College costs keep rising. Tuition fees have skyrocketed in recent years, and they’re only going to climb higher. Books are incredibly expensive. Every student now has to have a computer, and not a cheapie either. Plus there’s the cost of residence if the child goes out of town, of transportation, of walking-around money, and a dozen other things.
In another 10-20 years, it could cost $100,000 or more to send a child to a top-rated out-of-town school for a four-year degree.
Governments may make more money available for post-secondary education, but the main burden will be on the students and their parents. Unless you’re prepared to see your child weighed down with onerous student loans, the time to start planning is now.
RESP investment strategy
How? Most people are opting for registered education savings plans (RESPs), which have become much more popular since the introduction of the Canada Education Savings Grant (CESG) a couple of years ago. Under this plan, Ottawa contrutes up to $400 a year per child to an RESP (the formula is 20% of your contribution).
RESPs are not perfect, but since more people are using them it’s important to get the investment strategy right.
The starting point is the choice of plan. They come in a variety of shapes and sizes, from the traditional (and expensive) scholarship trusts to a basic savings-type program.
We recommend a self-directed RESP, with minimal annual costs and no up-front fees. The plan administrator should assume responsibility for applying for the government grants on your behalf and issue regular financial reports.
Surprisingly, the foreign content limitations do not apply to RESPs so you can invest the money anywhere you want.
Not tax deductible
RESP contributions are not tax deductible. However, you can withdraw your principal at any time, tax free. Therefore, your objective should be to invest in funds that are likely to generate above-average returns. That way, when the time comes to take your money out, there will be a substantial amount remaining to pay the college bills.
For example, suppose you contribute $2,000 a year to an RESP for 15 years. The government kicks in another $400, for a total of $2,400. If you invest the money conservatively, say in GICs that average 6%, the plan will be worth about $56,000 at the end of that time.
Once you’ve withdrawn your capital ($30,000), there will only be $26,000 left to put towards college. (You could leave your principal in the plan, of course, but it would be nice to get it back.)
Now let’s assume a different strategy. Instead of investing in GICs, you put the money into a portfolio of mutual funds that generates an average annual return of 10%. The total invested is the same.
At the end of 15 years, the RESP will be worth just over $76,000. Now you can take your capital out and leave $46,000 to put towards the college expenses. If you average 12% a year, the plan will be left with almost $60,000 after the withdrawal.
Clearly, the best strategy with an RESP is to try to maximize the return on investment. If the child is still young, the long time horizon makes this quite feasible.
Therefore, we recommend a portfolio of equity funds only for children aged 0-14. You will undoubtedly want to switch some of the funds as the years pass, weeding out poor performers and replacing them with stronger ones.
As the child approaches college age, the portfolio strategy should change. You don’t want to see years of careful investing go down the drain because of a sharp market correction at a critical time.
Therefore, once the child reaches 15 you should start to shift some of the assets out of equities into lower-risk fixed income securities. This will preserve capital and ensure liquidity for when the money is needed.
By the time the child is ready to start college, the plan should be entirely invested in safe securities that can be drawn on as required. You can then take out your principal and know that a big chunk of your child’s post-secondary money is safely in the bank.
Abridged from Mutual Funds Update, a monthly newsletter edited and published by Gordon Pape