Canadians are known for being easygoing. While it’s great for our reputation, it’s not a great approach to investing.
Choosing safety over performance makes sense if you’re retired, need stability and are trading off growth for income to live off your portfolio. But if you are saving for your kid’s postsecondary education, you need to get a little more aggressive. Here’s why.
You’re losing money to inflation
Novice investors think it’s safe keeping their kids’ future university funds in a savings account or GIC. But there’s a hidden monster gobbling up all your hard-earned money: inflation.
When you lock your money in a GIC paying a paltry 2.5 per cent and inflation is 2 per cent, you’re barely beating inflation. After taxes on the interest, inflation is beating you.
You’re preventing the stock market from doing the heavy lifting
Volatility scares people away from investing in the stock market. We should know – that was once us. But after 17 years of investing and 10 years of early retirement, we now know that investing in the stock market is the key to securing our son’s future. We also know that seasoned investors don’t think in days or months, they think in years and decades.
Investing safely also isn’t about picking individual stocks. It’s about betting on the index, and benefiting from the diversification, low fees and low maintenance that comes with exchange-traded funds (ETFs). By leveraging diversification and investing for the long term, you are letting the stock market raise most of the funds for your child’s postsecondary education.
You’re giving up free money
Want free tuition money for your kids? Contribute to a Registered Education Savings Plan (RESP) and the government tops you up by 20 per cent (up to a yearly maximum of $500 and a lifetime maximum of $7,200). That’s basically free money for your mini-me and yet, only 49 per cent of Canadians are taking advantage of an RESP.
Never say no to free money, that’s rule No. 1 of personal finance. You owe it to your kids. They’ll thank you when they’re not stressed about their tuition and living costs.
In addition to the 20-per-cent freebie, the other notable thing about the RESP is that it’s tax-deferred, meaning the investment gains on your contributions grow tax-free until it’s time to withdraw. Those gains then get added to your child’s income, but since they will be attending college or university and have little or no income, they will pay little to no taxes.
You’re not taking advantage of a long investment horizon
When it comes to investing for your child’s future education, start as early as possible. We mean it. We know it’s hard to think about buying ETFs when you’re so tired you could fall sleep at a heavy metal concert, but hear us out. The sooner you invest, the sooner you can experience the magic of exponential, compound growth. Albert Einstein called compounding the “eighth wonder of the world” and he wasn’t wrong.
The S&P 500 has delivered an average annual nominal return of 10.13 per cent since 1957. Since tuition money isn’t needed until college or university, you have an incredibly long 17 years of investment time.
By starting today, and investing $200 a month, using annual return of 10-per-cent average return on an aggressive 100-per-cent equity portfolio, that amount grows to a whopping $97,307 after 17 years. With the government’s contribution of 20 per cent in the RESP, it goes up to $115,760. Of that amount, you’ve only put in $40,800, but the investment gains and the government free money nearly tripled your contribution.
It’s also important to note over a 20-year period, the U.S. stock market has never lost money. Individual investors lose money by dancing in and out of the market, selling and buying at the wrong points.
In your case, since your child will not need the money until 17 years later, that’s a nearly guaranteed return because you have a long runway. You can also afford to take higher risks by picking 100-per-cent stocks, putting it on autopilot, and letting time and the stock market do the hard work.
Kristy Shen and Bryce Leung retired in their 30s and are authors of the bestselling book Quit Like a Millionaire.
