We recently opened a registered education savings plan for our one-year-old daughter at our TD Canada Trust branch, but the management expense ratio of the mutual fund we purchased is 2.5 per cent. Are there less expensive options for investing in RESPs, and if so could you recommend something?
Your best bet is to open a self-directed RESP with a discount broker. Since you already bank with TD, transferring your RESP to TD Direct Investing would be your easiest option, but you can choose any discount broker you wish.
With a self-directed RESP, you will have access to a much broader range of investments – including stocks, exchange-traded funds and mutual funds – than you can get with an RESP at your bank.
You’ll also be able to cut your costs dramatically. It’s possible to build a well-diversified portfolio of ETFs, for example, for an MER of less than 0.1 per cent – a tiny fraction of what your mutual fund charges.
Keeping costs low is important. Assuming your daughter attends postsecondary school, you could be contributing to her RESP for another 17 years or so, and over that time fees could have an enormous impact on the value of the plan.
For example, say the stock market returns 8 per cent annually over that time. All else being equal, a broad equity mutual fund with a 2.5-per-cent MER would be expected to post a net return, after fees, of 5.5 per cent, but an ETF with a 0.1-per-cent MER would return about 7.9 per cent. (This assumes the mutual fund and ETF invest in similar assets and achieve the same return, before expenses, as the market.)
Such a seemingly small difference is actually a big deal.
Continuing with the example, if you contributed $2,500 annually to the mutual fund, the account would be worth about $78,000 by the time your daughter is ready for postsecondary school. But if you chose the lower-cost ETF, the RESP would grow to about $100,000. The difference of $22,000 is roughly the cost of tuition and residence for an entire school year. (These calculations do not include the Canada Education Savings Grant, which would kick in an additional 20 per cent, or $500 annually, up to a maximum of $7,200 per beneficiary.)
If you’re comfortable investing in individual stocks, that’s also an option. But for many people, ETFs are a good choice because they provide broad diversification, eliminate the need to research individual companies and may reduce the impulse to trade frequently, which can hurt returns.
What sorts of ETFs should you buy? Assuming you can tolerate the risk, while your daughter is young you can afford to put most, if not all, of the RESP’s assets into equity ETFs. One example is the iShares Core S&P/TSX Capped Composite Index ETF (XIC), which has an MER of 0.06 per cent and provides broad exposure to Canadian stocks.
To improve diversification, you should also consider devoting a portion of the RESP to the U.S. market, which will give you exposure to important sectors such as information technology, health care and global consumer companies that are underrepresented in Canada. The BMO S&P 500 Index ETF (ZSP), for example, charges an MER of 0.09 per cent and trades in Canadian dollars on the Toronto Stock Exchange, thus saving you steep currency conversion costs you would face if you bought an ETF on a U.S. exchange.
Another great option is to choose an all-in-one ETF such as those offered by Vanguard Canada, iShares and BMO. These “portfolio” ETFs – which invest in a basket of other ETFs – have slightly higher MERs than simple index funds, but they are super convenient because they provide exposure to U.S., Canadian and foreign securities with a single purchase.
One-stop ETFs cover the full risk spectrum, from conservative funds that invest primarily in fixed-income securities to aggressive ETFs with 100 per cent of their assets in stocks. Vanguard’s Growth ETF Portfolio (VGRO), for instance, has about 80 per cent of its assets in equity ETFs, and the rest in bond ETFs. The MER is 0.25 per cent, which is still very reasonable.
With ETFs, the idea is to keep things simple. Apart from investing your annual RESP contributions – along with the Canada Education Savings Grant – you should resist the urge to tinker with your portfolio. Let time do the heavy lifting for you.
When your daughter is a few years away from graduating high school, however, you’ll want to dial back the equity weighting and add some bond ETFs or short-term guaranteed investment certificates to the mix. This will provide a cushion in the event of a market setback and prevent you from having to sell when stocks are down in price. With my son, who started university last fall, I made sure to have two years’ worth of school expenses set aside in cash and short-term GICs. When the pandemic sent markets reeling, I didn’t need to worry.
Your daughter is fortunate that you have started saving for her education while she is still in diapers. If you keep your costs down, stay diversified and avoid excessive trading, by the time she is ready to head off to university or college you will have one less thing to worry about.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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