Using Asset Allocation ETFs For Your RESP

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Includes: VUG
by: Dan Bortolotti
Summary

In many ways, RESPs are fundamentally different from retirement accounts such as RRSPs.

They typically have a shorter time horizon, and they are usually depleted within four or five years, once your child reaches post-secondary school.

In general, they are also much smaller than retirement accounts, since the most you can contribute is $50,000.

Asset allocation ETFs can provide one-stop shopping for RESPs

Q. Several years ago, an advisor recommended I hold a Canadian dividend ETF in an RESP for my son. Would this still be a good approach for someone just starting an RESP for their baby, or is there a better alternative, given the increasing number of ETF options?

- Pete in Halifax

A. In many ways, RESPs are fundamentally different from retirement accounts such as RRSPs. They typically have a shorter time horizon, and they are usually depleted within four or five years, once your child reaches post-secondary school. In general, they are also much smaller than retirement accounts, since the most you can contribute is $50,000. But the same principles of risk management apply, and holding nothing more than a Canadian dividend ETF in an education account doesn't provide enough diversification.

If you're opening a new RESP for a baby, then you have at least 18 years before you need to start withdrawing the money. So you should start with the goal of building a globally diversified portfolio, which includes all asset classes, not just Canadian dividend stocks. But the challenge - at least until recently - is that it can be difficult to build an efficient ETF portfolio when you only have a small amount to invest. To get the maximum RESP grant, you only need to contribute $2,500 annually, so the account is likely to be very small in the beginning.

The good news is that Canada's largest ETF providers - Vanguard, iShares, and BMO - have all recently launched so-called "asset allocation ETFs" that provide one-stop shopping. Each of these ETFs includes six or more underlying funds that hold bonds and stocks from around the world, allowing you to build a globally diversified portfolio with just a single trade. If you want to use ETFs in an RESP, these funds are ideal.

While your child is very young, you can afford a relatively aggressive approach, as long as you are comfortable with the volatility. For example, the Vanguard Growth ETF Portfolio (VGRO) (NYSEARCA:VUG) holds 80% stocks and 20% fixed income and could be a suitable holding for the first 10 or so years. If you would prefer something less volatile, all three ETF providers offer a balanced version with 60% stocks and 40% bonds.

Once your child gets close to high school age, it makes sense to dial back the risk significantly, since you want to be sure that a bear market won't jeopardize your child's education funding. That will likely mean gradually selling shares of the ETF in putting the proceeds in cash or fixed income (such as short-term GICs), to make sure the money is available when it's time to pay the tuition bills.

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.