Target Date Funds: A Smart Solution For Your RESP?
If you think of saving for retirement as a marathon and not a sprint, investing in an RESP might then be best described as a middle-distance event. That’s because unlike RRSPs, where you hold onto your investments for three or four decades before withdrawing the money in retirement, the process for RESPs is much more condensed – you know your child will need the money at or around age 18 to pay for their university or college education.
Related: How to set up an RESP
Because of this relatively short time frame, RESP investors need to decide how and when to shift their asset allocation from potentially equity-heavy early years into cash and guaranteed products in order to preserve capital when their child needs the money for school.
Target date funds for RESPs
One brilliant and yet under-the-radar solution for RESPs is a target date mutual fund. Target date funds have become popular offerings inside of employer-sponsored retirement savings plans (group RRSPs and defined contribution plans), yet of the big banks only RBC and BMO offer target date education funds for RESPs.
The point of a target date fund is to choose the date that closely matches your retirement (or the year your child is likely to go to college), invest your money and then leave it alone. The portfolio is designed to automatically rebalance as you age (or as the college start date nears) so as to reduce risk. The early years emphasize higher-risk equity funds but as you approach your target date the balance gradually shifts to lower-risk fixed income and money market funds.
RBC introduced target education funds in 2004 and has since grown this family of funds to approximately $1.67B in assets. Meanwhile, BMO’s target education portfolios started up in 2014 and has less than $20M in combined assets.
How do target date funds invest your money?
I looked at the RBC and BMO family of target education funds to see how they invest. Here’s what I found:
| Target fund | Equity % | Fixed income % | MER % |
| BMO Target Education 2035 | 80 | 20 | 1.70 |
| RBC Target 2030 Education Fund | 70 | 30 | 2.03 |
| BMO Target Education 2030 | 70 | 30 | 1.60 |
| RBC Target 2025 Education Fund | 55 | 45 | 1.93 |
| BMO Target Education 2025 | 62 | 38 | 1.50 |
| RBC Target 2020 Education Fund | 25 | 75 | 1.83 |
| BMO Target Education 2020 | 52 | 48 | 1.40 |
What about those fees?
These funds come with management fees of between 1.4 and 2.03 percent, depending on the target year, but before you dismiss them outright due to the higher MER, consider what you get for your fees.
We know that many Canadian equity mutual funds charge fees of 2 percent or more for a basket of stocks that closely resemble their benchmark (also known as closet indexers). Investors can easily build a similar portfolio of index funds or ETFs for a small fraction of the cost.
Related: How parents can give their kids a financial leg-up
But with a target date fund investors are truly paying for active management, with a fund that shifts its asset allocation to match your objectives. Target date fund investors can take a hands-off approach and not have to worry about making a huge mistake, such as leaving an RESP invested heavily in stocks just before their child needs to access the money.
For those reasons, plus the fact that the bulk of your investment growth comes from a 20% government matching contribution each year, makes the 2 percent fee a lot more palatable inside an RESP.
Can’t you replicate this on your own?
As a do-it-yourself investor I will attempt to replicate this RESP strategy on my own. My “target date”, so to speak, for my oldest child is 2027 and for my youngest is 2030. I’m still focused on growth at this stage, with 85 percent of their RESP funds invested in equities and only 15 percent in GICs.
I use the TD e-Series funds to invest their RESP money. The funds cost nothing to buy and sell, and altogether come with an ultra-low MER of 0.42 percent for an even split between Canadian, U.S., and International e-Series funds.
My plan is to gradually shift contributions into fixed income once my oldest child turns 10. By the time she turns 16, everything will be in cash or GICs.
What I’d like to see
Robo-advisors have an opportunity to tap into the target date fund market by offering an automated solution for investors based on the date that closely matches their retirement or the year in which their children are most likely to go to college.
Investors could get a portfolio of inexpensive and broad-market ETFs and have an online wealth management team to auto-rebalance their portfolio for a cost of less than 1 percent annually. Best of all, you wouldn’t even have to think about it beyond setting up automatic contributions and setting a target date.
What we really need is Vanguard to set up target date index funds in Canada, along the lines of what they have done in the US and Australia. Those BMO MERs are terrible. But certainly the BMO funds are preferable to making a big behavioural or strategic mistake as a DIY investor.
Hi Grant, it would be great if Vanguard introduced those funds to Canada. I’ll admit I was surprised to see that RBC’s target date education funds had over $1.6B under management, and even more surprised that the other big banks haven’t followed suit.
I have a question. Do you have separate RESPs for your kids or do you have a family RESP?
Part of me thinks that the group RESP (family version, not the awful group RESPs out there) would be better as you can get greater earnings and you can shift the money around better. For example, the oldest does 4 years and that’s it but the youngest wants to be doctor so you want to shift more money to the younger one to help pay for a longer education.
On the other hand, that could create resentment between the two kids if one got more than the other. Hmmm, it’s definitely something to think about.
Or, how about a group RESP up to a certain age then split it out evenly?
Hi KC, great question. We have a family RESP for our two kids. It is set up to track the contributions and grant money separately but all the money is held under one account. You’re right that the advantage of the family account is its flexibility to transfer money to another child, in case there’s a large variance between the cost of education or one chooses not to attend post-secondary.
I’m not sure about that creating any resentment, though. The RESP money will cover the cost of an average four-year program. If one child chooses a more expensive school or longer program then they’ll have to come up with a plan to cover the difference.
I am going to be setting up a RESP using the BMO target date funds as the province I am in has a 10% grant in addition to the federal grant, but it is only available through a very select number of providers which does not include any discount brokerages. Sure, I would like a lower MER, but it is simple and the grant money more than makes up for it. I think the BMO funds may be a little heavy on equities when it is only 4 years from drawing down the money (still 50%), but still losses shouldn’t be huge.
Hi Devin, sounds like a good plan! I agree on BMO’s fund being a little heavy on the equity side so close to the target date. I’ll ask what the fund starts to look like once you’re 1-2 years away and report back what I find.
Check out the performance of the 2030 plan.
http://fundfacts.bmo.com/advisorEnglish/BMO_LifeStage_Plus_2030_Fund-EN-Series_A.pdf
Maybe what you need to do is go with a Hybrid or Bimodal investing scheme using these funds for 40% of the RESP and use Index Funds for the remaining? That way you have the “peace of mind” of having an actively managed set of funds and the “holy crap, seat of my pants” investing of the Index funds? 🙂
Just an idea.
I started out with just the RBC Target fund back in 2007, and stayed with it for a few years. When the family RESP grew to include my 3rd child, I figured it was time to consider saving a little on the considerable MER – plus the target fund’s performance was lacklustre (but not terrible). I looked into the main holdings of the target fund, and decided on my own mix of ETF and index funds, a GIC, and a smaller REIT component as well. The trick at the time was finding an online brokerage I was comfortable with that could also handle both the federal and provincial matching grants (some are not setup to do so). qTrade was capable of handling the grants, and I’m happy with the perforance of my self-directed portfolio so far. I’ll be comfortable rebalancing when necessary in future years.
Thanks Dan for the suggestion and i’m hoping you must be sailing in better boat this year too. Quick question when there is selection about the ETF’s, what possible metrics do you look for, it would be helpful if share some from your portfolio as good examples.
When I see comments like “awful group plan” I wonder what the reason is. Scholarship plans have consistently outperformed the market and any of the target funds since they don’t have to liquidate near the maturity date. There are always enough liquid assets in the pool to pay out beneficiaries – no need to sacrifice return. The target funds have to perform superbly in the early years
for the relatively short time frame before they have to reduce the risk in the portfolio – we know the stock market can be volatile and in a 10 year time frame it is not a good risk. – invest at low risk in a pooled plan with a steady consistent rate and continue to participate in competitive earnings throughout the investment period, even if the child waits til they are 30 to use the money. – the targeted funds put the money in money market at the target date, which could be 4 years before your child graduates high school right up until they use the money (money market is paying less than 1/2% per year)
Overall, the fees over 18 years are so much lower than the 2% MER, that it is a major consideration even if about half of the group fees are collected up front. If you are in the plan for the long haul, why would front end load matter, when the long term rate of return is so much better.
Other arguments against group plans is the loss of EAPs if the child doesn’t go to school. Parents actively and knowingly participate in the scholarship options, which require a term committment from their children to complete the term they chose. However, the plans have increased flexibility significantly over the years and they all have the options to opt-out of the scholarship option and never lose any of the EAP they are entitled to.
If people have negative comments about group plans they should do their research before they speak as the plans may be the best option for some families.
I personally lost 20% of my RESP with a bank mutual fund. The fund never made up the loss before my girls went to college.
Hello all!
I opened my daughter’s RESP right after she was born in June 2016 at BMO. I initially simply opened the RESP to take advantage of the grant money and have since contributed $200.00/month without an issue. Now, I would like to move forward and actually invest the money, but, I am unsure how to proceed. BMO has their target portfolios, but, I am unsure if this is a wise choice. Please provide any form of guidance. Thank you so much.
For 2022 we contributed $4500 and received $800 in grants, and the current balance is $765 less than January 2022…
RBC Select Choices Aggressive Growth (2.56% MER) – hopefully they make up for it next year. Suggestions?