With all the suggestions for topics to write about (as part of last week’s contest), I thought I should start putting a dent into some of them. Invariably, I won’t get to answer all of them in a timely fashion but I’ll do my best.
One question came from DJ, who asked:
Do you have a rule of thumb for how much of an RESP should be invested in fixed income?
Please refrain from cyber-hitting me after hearing my answer:
Pretty flippant, eh? :)
I’m pretty sure some people were expecting some sort of sliding increase in fixed income as my recommendation, but that’s going to have to wait. While it may not be a bad starting point, it’s not necessarily the right answer for DJ.
Catch-all answers just don’t work. For example, Michael James on Money is a big believer of holding 100% equities unless you expect you’ll be needing money in three years, whereas Canadian Capitalist holds roughly 25% in fixed income in his long term portfolios. Both make compelling cases for their choices, so who is right? I would suggest that they are both right – for themselves. They both have the confidence to make the decision and stick with it – which is in part due to the amount of time they have put into researching the answers for themselves.
Additionally, if you come to your own conclusions you are more likely to stick with them over the long haul. How easy would it be to justify an outcome that isn’t meeting your expectations as being due to the wrong strategy if you didn’t come up with it yourself? Very easy. And this is one of the main reasons that investors are behind the curve when it comes to the returns on their portfolios and their relative ease in switching strategies (and normally at the wrong time).
Not too long ago, someone with a lifetime of investment management experience said the following, “30 years in the business running portfolios, an MBA and a CFA and I can tell you it’s all comes down to psychology.” I believe the same applies to all of personal finance in general.
There are a number of paradigm shifts going on in the financial industry in the next while: increased regulation (hopefully), wider acceptance on the active versus passive investment management “debate”, increased financial literacy and maybe way down the road some sort of reform with respect to delivery of financial advice in general (away from commissions). But at the top of that list needs to be psychology. More precisely: how people react to financial decisions and why. If we begin to really understand these questions, the investment landscape will be much better off.
I realize I’ve gone on a bit of a rant here. :)
While I hurry up and wait for the financial world to reach my utopia, DJ may want to consider the following:
1. If you are going to be adding contributions on a regular basis, you can increase your risk tolerance as dollar cost averaging allows one to start off with a riskier portfolio to begin with while still allowing one to sleep at night. Personally, I would put monthly contributions into 100% equities.
2. You can slowly ween off of equities by the time your child is expected to matriculate. Again, I would personally start at 100% equities (in the form of monthly contributions) and every birthday, change the current portfolio to have 5% fixed income more than the previous year. So my monthly contributions would be to an all equity portfolio always, but each year I would slowly convert more assets to fixed income. By the time my child was 10, the monthly contributions would still be going to equities, but the overall portfolio already invested would be at about 50% fixed income. By the time he/she was 15, monthly contributions are still all equities, but overall portfolio is closer to 75% fixed income.
Is this the perfect answer? Absolutely not. The best thing would be for DJ to come up with something on his own based on studying the markets, historical portfolios, and reading some books on personal finance in general. I realize that many people don’t have the time or inclination to really want to commit to educating themselves on this stuff, but money is a big part of everyone’s lives, like it or not. No one should be more interested in your personal finances than YOU.
Now, some people cannot even tolerate a monthly loss of $100 on $10,000 (1%), so if DJ were to fall into this group, he/she would want to consider a GIC ladder or a high interest savings account.
Theory is great… in theory. But in real life, it’s a whole different ball game. DJ, sorry for taking a while before actually giving you some food for thought on your question. I urge you to do some further digging and perhaps share with us what you’ve come up with – I would be happy to post your answer and discuss it some more for everyone else’s benefit too. Who knows, you might even change how I plan to manage my future child’s RESP! :)