Friday, October 2, 2015

Why a Dividend Guy Would Index His Son’s Education Savings Plan

Unless this is your first time visiting my blog, you probably know I’m a big fan of dividend growth investing. This strategy and its resulting steadily rising passive income stream are an essential element of funding my early retirement plan. Despite being such a passionate proponent of dividend growth investing, I have decided to invest my son’s Registered Education Savings Plan (“RESP”) in index exchange traded funds (“ETFs”).  Below are the four reasons I decided to use index ETFs for my son’s RESP.

Transaction Costs

One of the key benefits offered by my discount brokerage (Scotia iTrade) is that it allows users to buy and sell a list of 50 ETFs without incurring any commissions. Since my wife and I plan to fully fund my son’s account each year ($2,500) in order to qualify for the Government of Canada top-up ($500), minimizing transaction costs while creating a diversified portfolio are key considerations. Trying to create a diversified portfolio of individual stocks while incurring $10 transaction costs for each purchase of individual stocks would be extremely challenging, at least in the first 10 years of the portfolio. By investing in a combination of 3 or 4 index ETFs, our plan is to eliminate transaction costs, while achieving the benefits of diversification. The downside is that management expenses of the ETFs will bite into returns, but should be minimized by the ETF companies through competition (i.e. between Blackrock and Vanguard).

Passive vs Active Management

As my investment portfolio has grown over the years, I spend more time researching companies, keeping abreast of developments of my existing holdings, and searching for opportunities to buy and sell securities. Although I enjoy performing the above activities, I also acknowledge that time spent managing investments could be better spent in other areas of my life. By taking a passive approach to managing the investments in my son’s RESP, and likely only rebalancing once per year, I hope to minimize the amount of time I spend managing the RESP.

Risk Profile

Given my participation in a defined benefit (“DB”) plan at my current employer and two DB plans while with past employers, I can afford to take a fair amount of risk with my own investments. In contrast, my son’s ability to take on investment risk during the first 18 years of his life is limited, as his external sources of income will be constrained (i.e. gifts, allowances, a part time job).  Since my son’s risk profile will be vastly different than mine, it only makes sense that his investment holdings are less risky and reflect the difference.

Investment Objectives

The goal of my son’s RESP is to pay for his post-secondary education. This will require a fixed amount of money over a short period of time.  My portfolio’s objective is to generate sufficient passive and rising income to offset my living expenses in the future. In other words, I need a growing amount of money over a long period of time.  The different securities held in our respective portfolios will reflect the different investment objectives.

Of the four reasons outlined above for different approaches, perhaps the most important is passive vs active management.  As much as I look forward to using the RESP as a way to teach my son about saving, investing, and generating passive income, I’d rather spend more time with him, instead of time spent managing his investment portfolio. The only remaining decision on the RESP is what 3 or 4 funds to select to achieve the greatest diversification, by asset class and geographical area, at the lowest cost in terms of management expense ratios charged by the funds.

How do you invest for your child’s education?  

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