What’s the best asset allocation strategy for your child’s RESP?

No matter how you describe the Canadian dream, at some point in your life, it involves giving your child the best post-secondary education. But as education costs continue to soar, how can you afford to make that dream come true?

Statistics Canada suggests that university students could face tuition bills in excess of $27,000 for a four-year program. That tab doesn’t include the cost of books, food, transportation, inflation, or residence if your youngster studies away from home.

Fortunately, a registered education savings plan (RESP) is designed to help you defray those costs. By opening and funding an RESP, you benefit from tax-sheltered growth inside the plan. You also gain access to the government’s Canada Education Savings Grant (CESG), which can kick in a maximum of $7,200 over the life of the plan.

Setting up an effective asset allocation strategy is key to maximizing the benefits of an RESP. This involves regularly monitoring your RESP and rebalancing your portfolio as your child gets older. Your child’s age and your risk profile should help lay the foundation of your RESP investment strategy. As these two factors evolve, so should your strategy. Here’s a look at how you can build a robust RESP portfolio.

The RESP timeline

Your child’s age defines your RESP timeline. If you’re setting up an RESP for a newborn, the  child won’t likely need to access the funds for about 18 years. But if you’re opening an RESP for an older child, then your time horizon will be shorter. Your teenage son or daughter will need to access the funds sooner. Different timelines mean shifting investment strategies. A good guideline to work from is, the younger your child, the more growth-oriented your RESP portfolio can be. The money won’t be withdrawn for several years, so your portfolio has time to recover from any market downturns.

Risk profile

Next comes your risk profile. If you invest in stock markets, will you get the jitters every time stocks go on a bumpy ride? If so, you might want to concentrate your investments in less risky fixed-income assets, even if you’re setting up the RESP for a younger child. But remember that the lower the risk, the lower your expected return. If you’re comfortable riding out market volatility, you may choose to focus on stocks, especially while your child is still young.

If you invest too conservatively early on, you could be missing out on growth potential that could allow your investment to increase. Conversely, if you’re too aggressive, as the timeline shortens, you risk locking in losses that reduce the funds available. If you’re not confident that you can strike the right balance, you may want to consider using an automated investment provider that does the asset allocation for you. Qtrade Guided Portfolios for example, offer investors a convenient way to establish an investment portfolio through an online risk-assessment tool that calculates an appropriate asset allocation based on timeline, financial goals and risk tolerance.

Sample asset allocation progression

Consider the following scenario when allocating your assets across the RESP. From the birth of your child to around age eight, you’re looking at a longer time horizon of 10 years or more. Conventional wisdom points to a growth-oriented portfolio with a focus on equities. While it’s always possible for stock values to dip, the longer time horizon gives the portfolio time to recover.

From age nine to 13, it’s time to revisit your investment strategy as your time horizon begins to shorten. A heavy exposure to stocks can be tempting, but a narrower window of time makes the portfolio more vulnerable to a significant market downturn. Tilting your portfolio towards a more balanced strategy, with a greater emphasis on fixed-income and cash-based investments, should stand a better chance of preserving your capital. At this point, you could focus on lower-risk investments to anchor your portfolio. Another option would be to invest in a hybrid or balanced fund. These funds can evenly split assets between equities and bonds, helping you balance growth and risk.

As your child nears high school graduation, it’s prudent to adopt a safety-oriented asset allocation strategy. Your child will need to access the funds soon, and you need to limit your exposure to risk. Holding the money in Guaranteed Investment Certificates (GICs) or a money market fund within the RESP is one way to go.

Other investment options

As an online investor, the sky is the limit when it comes to RESP portfolio construction. There are various types of investments you can use to fulfill your RESP asset allocation strategy. Consider the following investment options that can help you put your eggs in different baskets.

• All-in-one exchange-traded funds (ETFs): These allow you to diversify your assets across global markets, while automatically rebalancing your portfolio to maintain a desired value split among different classes.
• Life-cycle funds: A type of asset-allocation mutual fund that automatically rebalances your assets throughout the course of your investment time horizon. Adjustments start from a profile of higher risk then shift to a lower risk as you approach the date of funds withdrawal.
• A High Interest Savings Account (HISA): As its name suggests, a HISA pays higher interest than standard savings accounts and constitutes a practical approach to security with some growth.
• Money market ETFs: These offer investment opportunities in high-quality and very liquid short-term debt instruments such as U.S Treasury bonds.

Keep in mind that maintaining a well-diversified portfolio of investments— including equities and fixed income, spread across different sectors and geographies— is a highly regarded approach to achieving growth while mitigating the effects of market ups and downs. Your RESP isn’t limited to one particular asset class. Everything from cash and mutual funds to GICs, stocks, bonds and ETFs can be used to build up your RESP.

As you approach the date of decumulation, you may want to gradually shift to a more conservative strategy, particularly if your initial strategy was strongly growth oriented. If all goes well, when the time comes for your child to start post-secondary education, you won’t be dreading a staggering tuition tab thanks to your RESP savings.

For more information on RESPs, download our Guide to RESPs and education savings.