With all the suggestions for topics to write about (as part of last week’s contest), I thought I should start putting a dent into some of them. Invariably, I won’t get to answer all of them in a timely fashion but I’ll do my best.
One question came from DJ, who asked:
Do you have a rule of thumb for how much of an RESP should be invested in fixed income?
Please refrain from cyber-hitting me after hearing my answer:
No
Pretty flippant, eh? :)
I’m pretty sure some people were expecting some sort of sliding increase in fixed income as my recommendation, but that’s going to have to wait. While it may not be a bad starting point, it’s not necessarily the right answer for DJ.
Catch-all answers just don’t work. For example, Michael James on Money is a big believer of holding 100% equities unless you expect you’ll be needing money in three years, whereas Canadian Capitalist holds roughly 25% in fixed income in his long term portfolios. Both make compelling cases for their choices, so who is right? I would suggest that they are both right – for themselves. They both have the confidence to make the decision and stick with it – which is in part due to the amount of time they have put into researching the answers for themselves.
Additionally, if you come to your own conclusions you are more likely to stick with them over the long haul. How easy would it be to justify an outcome that isn’t meeting your expectations as being due to the wrong strategy if you didn’t come up with it yourself? Very easy. And this is one of the main reasons that investors are behind the curve when it comes to the returns on their portfolios and their relative ease in switching strategies (and normally at the wrong time).
Not too long ago, someone with a lifetime of investment management experience said the following, “30 years in the business running portfolios, an MBA and a CFA and I can tell you it’s all comes down to psychology.” I believe the same applies to all of personal finance in general.
There are a number of paradigm shifts going on in the financial industry in the next while: increased regulation (hopefully), wider acceptance on the active versus passive investment management “debate”, increased financial literacy and maybe way down the road some sort of reform with respect to delivery of financial advice in general (away from commissions). But at the top of that list needs to be psychology. More precisely: how people react to financial decisions and why. If we begin to really understand these questions, the investment landscape will be much better off.
I realize I’ve gone on a bit of a rant here. :)
While I hurry up and wait for the financial world to reach my utopia, DJ may want to consider the following:
1. If you are going to be adding contributions on a regular basis, you can increase your risk tolerance as dollar cost averaging allows one to start off with a riskier portfolio to begin with while still allowing one to sleep at night. Personally, I would put monthly contributions into 100% equities.
2. You can slowly ween off of equities by the time your child is expected to matriculate. Again, I would personally start at 100% equities (in the form of monthly contributions) and every birthday, change the current portfolio to have 5% fixed income more than the previous year. So my monthly contributions would be to an all equity portfolio always, but each year I would slowly convert more assets to fixed income. By the time my child was 10, the monthly contributions would still be going to equities, but the overall portfolio already invested would be at about 50% fixed income. By the time he/she was 15, monthly contributions are still all equities, but overall portfolio is closer to 75% fixed income.
Is this the perfect answer? Absolutely not. The best thing would be for DJ to come up with something on his own based on studying the markets, historical portfolios, and reading some books on personal finance in general. I realize that many people don’t have the time or inclination to really want to commit to educating themselves on this stuff, but money is a big part of everyone’s lives, like it or not. No one should be more interested in your personal finances than YOU.
Now, some people cannot even tolerate a monthly loss of $100 on $10,000 (1%), so if DJ were to fall into this group, he/she would want to consider a GIC ladder or a high interest savings account.
Theory is great… in theory. But in real life, it’s a whole different ball game. DJ, sorry for taking a while before actually giving you some food for thought on your question. I urge you to do some further digging and perhaps share with us what you’ve come up with – I would be happy to post your answer and discuss it some more for everyone else’s benefit too. Who knows, you might even change how I plan to manage my future child’s RESP! :)
In theory the asset allocation of fixed income and equities in a RESP should change as the date at which the funds start being withdrawn approaches. The closer one gets to using the funds the greater the portion in fixed inccome and the more conservative a portfolio become. Because of this, target date funds whcih are used for retirement are quite appropriate for RESPs as well.
Thanks for the mention. The older I get, the more I realize how we are all driven by our emotions. From a purely logical point of view, there probably is a “best” answer to the question of how to invest RESP funds, but it doesn’t matter much if it causes the investor to lose sleep at night, or worse to sell in a panic at the wrong time. I’m an advocate of using reason to overcome emotional reactions to the extent possible, but not many people seem willing and able to do this.
I’d be more inclined to agree with Ken Hawkins’ comment about target date funds if I was aware of even a single target date fund that didn’t charge outrageously high fees.
What difference does it make whether you rebalance using existing funds or new contributions? I see no need to keep contributing to equities if you’re simultaneously shifting some of those equities into fixed-income. Just apply enough of your new contributions to fixed-income to keep the asset balance you want, and when you can’t do that anymore, then you can start moving the existing funds to make up the difference.
What I use in the RESP for my son is to have it 100% in equities up until age 10, and then will be balancing from age 10 – 17 to reduce the exposure and have nearly all fixed income by the time he is 17. It’s as good a plan as any, and he will have more for education from me than I did from my parents (None, other than housing, which is HUGE anyway).
For my daughter a couple of years earlier when I was young and naive I trusted a CST rep to set my daughter up with their group RESP. Please for the love of anyone in your life avoid group RESPs like the plague. It’s the worst decision I ever made financially.
Thanks for the mention Preet. I’d agree with Ken that the key question is this: how many years does DJ’s child have until University? If there is five years or less, I’d go very light on equities. My kids are three and a good case can be made that their entire fund should be in equities but boy am I glad that I kept some in bonds and rebalanced when the market turned down.
@ Ken Hawkins & Michael James – I agree, the extra costs of target date wraps make them a poor choice for anyone who can manage their own money. For those who cannot, they may be of appeal to those willing to pay for some peace of mind when it comes to rules of thumbs.
@ Patrick – you are quite right. The transactional costs would be higher with what I proposed, and lower with yours if managing your own money. If using mutual funds from the same provider, switching fees would be zero, and it would be less cumbersome from a paperwork point of view (just keep the PAC running and make a switch once a year).
@ Traciatim – thanks for the note about those group plans, totally agree. If you ever want to write a guest post on your experience, please submit at your convenience, happy to post it.
i like your idea.Thanks for the mention Preet. I’d agree with Ken that the key question is this: how many years does DJ’s child have until University?
I would say even more than 20%, about 50% in such situation in my opinion but I may be wrong of course. http://www.homecaredirect.co.uk
20% if the child is young, increase the portion as one approach 18