On the show today we are going back to basics, just Cameron and Benjamin going through some useful topics for your financial benefit! We start talking about GIC's and the article on MoneySense that led to this conversation. GIC's have a somewhat mix and match reputation, one which we believe has been often misunderstood and misrepresented. We try to show in which ways people have been misled into thinking that GIC's are the best option when, we believe, they are not. From there we turn to more general portfolio ideas, comparing the performance of the S&P 500 over time and drawing on a very useful study that illuminates the index's limitations. Our last topic for today is around saving for college and RESP's or registered education saving plans. We talk about asset allocation, how to think about starting and best practices when drawing on these funds. We finish off the show with some bad advice regarding dividend investing that actually referenced a video we made! So for all and a bunch more great stuff, be sure to tune in today!

Key Points From This Episode: 

• Our recent summer travels and getting away from it all! [0:03:02.4]

• The article by Jonathan Chevreau that sparked part of today's discussion. [0:05:46]

• GIC's, long term returns and the financial implications of your choices now. [0:07:15.2]

• Reasons why returns on GIC's can be misleading in the short term. [0:11:02.7]

• The S&P 500's performance against other portfolio options. [0:13:56.3]

• Market drops and risk appetites during panic periods. [0:19:15.2]

• Saving and drawing on college funds and education plans. [0:22:40.2]

• Asset allocation and the best way to think about covering costs. [0:27:41.1]

• Withdrawing funds and making the most of unused college savings. [0:31:21.3]

• This week's bad advice! An argument about dividend investing. [0:33:30.8]

Read the Transcript:

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision making for Canadians. We’re hosted by me, Benjamin Felix, and Cameron Passmore.  

The intro says for Canadians, but we’re getting a lot of non-Canadian downloads. 

Cameron Passmore: All over the world. We’re even ranking in Spain, I saw, on Spotify. 

Ben Felix: I knew you were there maybe. 

Cameron Passmore: Perhaps. 

Ben Felix: Anyway. So, yes, we’re in Canada. A lot of this is pretty Canadian-centric, but feel free to listen from anywhere. 

Cameron Passmore: We have great guests like in the states and we will get more Canadian guest. But boy, we’ve had a run of phenomenal interviews. 

Ben Felix: Yeah.  

Cameron Passmore: And Barry is up next, which will be good.

Ben Felix: Yeah. I think that if anyone’s listening to this and has not listened to the David Blitzer episode, I think that the title – It was like the history of the S&P 500. The title looks super boring. That interview was fantastic. If you haven’t listened to it – 

Cameron Passmore: Yeah, and we’re also getting great feedback on last week’s, which was Jonathan Clements. That was a great interview also. Even he commented on Twitter saying he didn’t realize how much better interviews are when they’re in person as supposed over the phone.

Ben Felix: Oh! I didn’t see that tweet. That’s good.  

Cameron Passmore: Yeah. So nice of him. We have an offer to throw. I’ll just do a little beta test. We got some Rational Reminder swag. So if you’d go and put a review, which we really appreciate, and there’re been some very kind reviews, which we, again, appreciate a lot. If you happen to do one, drop us a not that you’ve done and tell us which one it is and we’ll get you a choice of a limited edition coffee mug, or these swanky super sock.  

Ben Felix: It’s got to be the shirt, I think.

Cameron Passmore: Cotton shirt. Well, people might like the mug. 

Ben Felix: Yeah, you’re right. You’re right. 

Cameron Passmore: I’m sure it’s pretty snappy. 

Ben Felix: We debated making an offer like this, because we don’t want it to seem like we’re buying reviews. Yeah, we like – We started doing this podcast and like – I don’t know, you’re doing a podcast. So, why not get some mugs I guess? 

Cameron Passmore: Want to get swag. 

Ben Felix: Then it’s like maybe we’ll get some shirts, I guess. Now, we’ve got these mugs and shirts, but it’s like, “What are you to do?” I told Cameron we should just get two mugs, but she convinced me we should get more. 

Cameron Passmore: So, we did get two. I got him two and I got 98. So, we have all these mugs and t-shirts here. Do, drop us a note if you put a review on that. It’d be great.

Ben Felix:  Yeah. Write a review on iTunes or I guess whatever platform and send us an email telling us which one it was, and I guess your address, and we’ll send you some rational reminder swag. The mugs are cool too, but the shirts are pretty cool. In my –

Cameron Passmore: We’re back after in vacation for a few weeks. Some good topics, education discussion, S&P 500.

Ben Felix: Education. Yup. It’s good. Good episode. We’ll keep the intro short. 

Cameron Passmore: There we go. 

Ben Felix: Welcome to episode 56 of the Rational Reminder Podcast. It’s Cameron and I back together.

Cameron Passmore: It feels like it’s been a long time since we’ve been in front of the mic. We’re feeling kind of rusty. 

Ben Felix: We had a few guests in a row, which we don’t usually do, but we were both away and we were feeling rushed to get an episode recorded. So we just decided to fit one of our prerecorded guest episodes in.

Cameron Passmore: I haven’t really seen you. Can you briefly say what your trip was?

Ben Felix: I know. I haven’t seen you either. Yeah. So, went to – I drove from here in Ottawa to Nova Scotia, and then took the ferry over to Newfoundland and then – 

Cameron Passmore: How long was that ferry ride?

Ben Felix: Seven hours there, but it took you to Port aux Basques, which is one end of the island. Then we had to drive all the way across to St. Johns. We did that intentionally. We wanted to do the drive. Then on the way back, we took a different ferry from Argentia, which is 17 hours. Sleep on a ferry. Yeah, it’s great.

Cameron Passmore: Kids must have loved it.

Ben Felix: Yeah, it’s great. Kids loved it. Yeah. People seem to think we’re crazy for doing a road trip with three young kids. But it was totally fine. Kids were great.

Cameron Passmore: It’s awesome.

Ben Felix: I spent four full days deep in the woods hiking and camping with a friend of mine right on the coast on East Coast Trail, which that was quite an experience. 

Cameron Passmore: You were literally off the grid for that time.

Ben Felix: Oh, yeah. No cell services. It was a little bit – I don’t know what I’d call it. Intimidating, where there were points where we had no cell service and you’re an 8-hour hike in both directions away from any civilization.

Cameron Passmore: So, if something went wrong, trouble.

Ben Felix: Yeah, exactly. But it was amazing. When we were in that spot, we ran into this pot of humpback whales. So we’re probably 100 feet away from these, obviously, massive whales summoned around, breaching out of the water and stuff. 

Cameron Passmore: Wow! 

Ben Felix: It was cool.

Cameron Passmore: Very cool.

Ben Felix: Where were you?

Cameron Passmore: Almost two weeks in Spain. I went to Barcelona for a few days. What an incredible city. Unreal. Superhot, great weather, great city, lots of interesting attractions and the architecture and whole Gaudi part of town. Then you get the beach there on the Mediterranean. We toured around during the day and hangout at the beach. Then we had a week on the Island of Majorca in Palma. Again, amazing town. We were in this little boutique hotel. We’re in the old fishing part of town and, again, walked the beach, and beautiful, old. My gosh! It’s so old. The city is in little narrow lanes. We had a great, great time. What a fabulous food and interesting people. It’s really nice. 

But now we’re back again. So, I guess that was our current topic. Number one, was our travels.

Ben Felix: How much time did you spend thinking about bond fond versus GICs while you’re away?

Cameron Passmore: I did not spend a lot of time thinking about that. But I know you wanted to talk about it.

Ben Felix: Oh, yeah. I thought about it a lot. No. I’m just kidding. I thought about it before, before we left. So, we’re calling it a current topic. We’re filling into that slot of our podcast. But, it’s kind of a portfolio topic, but it’s also kind of a financial planning topic. But the reason we’re calling it a current topic is that it’s based on an article that John Chevreau just wrote for MoneySense, and I was quoted pretty extensively in the article. The title of the article and the question that it’s answering is are GICs right for retirees who want fixed income? What do you think?

Cameron Passmore: I’m always amazed at how many articles you read, where advisors slam any sort of pooled alternative, like any sort of bond fund or bond ETF. I’m always amazed at how many people just love GICs, even though it’s just a repackaging of some fixed income investment. 

Ben Felix: I think a lot of that preference for GICs that you see from people is a lack of understanding of what’s actually going on from an economic perspective. When you own a bond fun, people think it’s scary. I mean, bond index, they’re not super easy to understand. The management of a bond index fund is not super easy to understand. It’s very much different from a stock index fund. The biggest one is that bond funds change in price. If you have a bond fund in your account, it can become – The market value can get lower than the book value and you think, “Oh, no! I’m losing money on my fixed income. This isn’t safe at all.”

Cameron Passmore: Yeah, and if you don’t understand what you’re buying – I can remember, and I may have told this story before, but – Gosh! Probably 25 years ago. I worked with someone who recommended people put short-term money into a long-term bond fund, and that’s when rates spiked is early 90s, and rate spiked overnight. I forgot all the details, but I remember that that fund went down I believe probably 10% or 15% overnight, and that’s when someone learned a lesson pretty quickly what duration is. 

So, I agree. When you buy a GIC, you don’t have to worry about duration. But when you’re buying any sort of pooled product or even a bond, you have to worry about duration.

Ben Felix: But this is the tricky thing, is that even when we have a GIC, if you have a 5-year GIC and a 5-year bond fund. Say, they have similar duration just for argument’s sake. The bond fund is still going to change in price if interest rates change. The GIC is not going to change in price, but the economic effect on you if interest rates go up and you still have this GIC locked in at 2.5%, you’re now taking that 2.5% while everybody else is earning 3.5%.

Cameron Passmore: Right. But you can see people that buy GICs just don’t want to worry about it. I’ll worry about my price variability on the equity side of my portfolio, but I want to pin down my GICs, and I know what I’m going to get in maturity.

Ben Felix: That’s the problem. This is what I was saying, is that in both cases, the economic effect on your portfolio is the same. 

Cameron Passmore: I agree, obviously, and it’s much harder to rebalance portfolios with GICs, because you don’t have liquidity.

Ben Felix: Yeah, lack of liquidity. Then one of the big ones, and we’re just kind of talking about duration, is that with GICs – And maybe this is fine. Maybe it’s fine to have a shorter term tilt in your fixed income portfolio. I mean, even if we look at the fixed income that we use from dimensional. It’s got a shorter average duration than like VAB and like Vanguard Aggregate Bond index. So maybe if –

Cameron Passmore: That’s what? Around 8? The dimensional one is probably between two and three. 

Ben Felix: A little higher, I think. 

Cameron Passmore: So, you should probably define duration for people who may not know what duration is.

Ben Felix: The amount that the price would change in the bond portfolio with a 1% change in interest rates. That’s the modified duration. 

Cameron Passmore: The higher the duration, the more sensitive you are to rising interest rates. 

Ben Felix: Another way to think about it is how long it would take for you to recoup your loss all else equal with a 1% change in interest rates. 1% increase in interest rates. Anyway, a simpler way to think about it is that longer durations are generally riskier, because you’re going to have bigger price changes with interest rates.
But, as we know, risk and expected returns are often related specifically when we’re talking about risks that are priced, which term risk duration is one of those. It’s a priced risk. So you expect a positive return for taking on term risk, or maturity risk, whatever you want to call it.

Cameron Passmore: You got to wonder how much money flowed out of bond ETFs and bond funds last year into GICs. I’d love to know what that aggregate number is, and you want to look at what the returns have been so far this year on these bond funds. Many have done between 5% and 8% year to date.

Ben Felix: Right. Yeah, they’ve been fantastic.

Cameron Passmore: Even plain index one is done that well.

Ben Felix: Yeah. Oh, yeah. Well, VAB has done extremely well.

Cameron Passmore: That’s the total bond index.

Ben Felix: Canadian bond and VBG, which is Vanguard Global Aggregate. 

Cameron Passmore: Ex-US.

Ben Felix: Ex-US. It’s also done really well. But you look back last year, the one and even three-year returns, for those bond funds, were pretty bad. But all of a sudden you go back and revisit those 12-month and 3-year returns after this six month period, and they look pretty great. So if you’re comparing GICs to bond funds last year, say, in December of last year, of course, it looks like GICs were the better option, and they were over that time period. But returns as we know come quick. They come in – Well, in this case, in six months, whatever. 

Cameron Passmore: I just looked at the DFA global fix income fund over the past five years, the return has been 3. – Just over 3%, 3.07, and it went back and found a 5-year GIC posted 5 years ago, and it’s 2.55. I noticed just one little micro example, but in the fund, you had liquidity the whole time able to rebalance.

Ben Felix: And it’s globally diversified. So, you’re getting exposure to fixed income across the world. You’re not focused on Canadian fixed income, which there’s probably some value too. I did a blog post earlier. I’ve got the numbers here for – Yeah, so VAB. At the end of the 2018, the one-year return was 1.16% and three year return was 1.56%. That’s for Vanguard aggregate bond at the end of last year. 

Cameron Passmore: Which is white people will say, “I could have bought a GIC and done better.”

Ben Felix: Right. Then you look now or as of June 2019, VAB is up year to date, 7.24% at the end of June. The three year trailing return is 2.34%. Now, it’s before tax. I didn’t look at the after tax returns for VAB ending June, but I did this blog post earlier this year looking at a 5-year GIC ladder that I created using historical GIC rates. So, it’s like a rolled – A perpetually rolling 5-year GIC ladder, and I compared that to ZAG, the BMO Canadian aggregate fund both before and after tax over that period. Obviously, this is going to change depending on the time period. But over that time period, the bond fund beat the GIC ladder before and after tax. Because one of the things with bond funds is people get worried about the premium bond issue, which can be an issue, is an issue. But even with that.  

Cameron Passmore: To me, I get so much peace of mind having it in pooled funds because you know it’s taking care of, whereas people view the GICs as being taken care of. No. Just give me the bond allocation. You can rebalance as you see fit based on your overall asset allocation. So, I get more stressed if I was to own GICs, but I guess a lot of people like the peace of mind of GICs.

Ben Felix: It’s a psychological – Well, I guess that is what peace of mind is. But it’s a psychological benefit. From an economic perspective with a rise in interest rates, you’re no better off with GICs than you are with bond fund.

Cameron Passmore: So why does so many advisors disagree with you?

Ben Felix: I don’t know. They don’t understand the economic impact of interest rate change on GICs, maybe. I don’t know what to tell you. With a bond fun, yes, it’s going to drop in price if interest rates go up. But then you’re still receiving coupon payments from your bonds. You’re still receiving maturities. Well, you’re probably not receiving maturities. When a bond fund gets too short a maturity, it’s sold inside the bond index. Anyway, you’re getting cash flows coming in. As soon as your interest rates rise, you can now take all of your cash flows from the bonds that you’re holding the bond ETF and reinvesting with a now higher interest rates. You can’t do that with a GIC until it matures. 

Cameron Passmore: Correct.

Ben Felix: Unless you have some sort of monthly interest GIC maybe. I don’t know. Do those exist monthly? I don’t know if you can annual GICs. 

Cameron Passmore: Anyway, then you got to manage it.

Ben Felix: Right. Then you’ve got a reinvestment risk. That’s absolutely true. I guess you have the bond fund too though. Anyway, there’s a paper that Vanguard did last year just showing that having some amount of – There’s a diminishing return to doing this. I can remember what the optimal, or I don’t know if there was an optimal allocation. But having some amount of global fixed income hedge to Canadian dollars really improved the risk adjustment returns of fixed income.

Cameron Passmore: But that makes sense. You’re getting exposure to different yield curves.

Ben Felix: Of course, different economies. So, of course, it makes sense. Different interest environments, all that stuff. Obviously, if you’re doing GICs or all Canadians bonds even, you’re missing out on that. I think that’s about it for that. 

Cameron Passmore: Yeah. I think that’s good. So, next topic, the portfolio topic, is a subject that you’re doing a video on soon. 

Ben Felix: Yup. It is done, but it is an interesting one, where people often ask this question of – And I know Dan did an article for MoneySense about this a year or two years ago, but it comes up often enough. 

Cameron Passmore: Dan Bortolotti. Couch Potato.

Ben Felix: Yeah, Dan Bortolotti. Canadian Cough Potato. It comes up often enough that I thought it was worth addressing. But the question is, is the S&P 500 globally diversified? The argument goes that it gets – The companies within the index get about half of their revenues from foreign sources. Therefore, you’ve got foreign –

Cameron Passmore: Coke is a global company.

Ben Felix: Right, stuff like that. Apple is a global company. All that kind of stuff. The other piece of that whole argument is that the S&P 500 has done really well. It’s beaten everything. 

Cameron Passmore: Yeah, and we’ve talked about that a number of times.

Ben Felix: It’s beaten active funds, beaten the U.S. market as a hole. It’s beaten global stocks, whatever you want. Maybe it hasn’t beaten Bitcoin, I guess. Does Bitcoin beat the – Yeah, Bitcoin’s beaten the S&P 500. There we go.

Cameron Passmore: Oh, it did?

Ben Felix: So, the S&P 500 is not that great then if Bitcoin can beat it. I’m just joking, obviously. The other argument is that correlations between global stocks are increasing. So why should you even globally diversify if you’re not getting a low correlation when you add global stocks to your –

Cameron Passmore: That’s especially true when things go negative, correct?

Ben Felix: Correlations increase –

Cameron Passmore: Going back in the crisis. Everyone panics together.  

Ben Felix: Exactly.

Cameron Passmore: Not necessarily the same amount, but the direction is the same in panic times.

Ben Felix: Correct. All correlations increase in panic times. Yeah, markets drop together in panic times. So, I think with –

Cameron Passmore: So, people getting lulled in a sense of comfort with just owning more and more U.S. stocks. Because so many people are questioning on Twitter, a number of people that we follow who are in kind of factor framework saying like is factor investing dead? Should you just go along U.S. grow stocks and that’s it?

Ben Felix: We’ve talked about this before. Is it different this time, all that stuff? I think that with the S&P 500 – So, let’s not necessarily U.S. grow stocks, but there are some in there. Well, a lot probably. But if we just look at the S&P 500, I love that. We’ve talked about this before. So, if anyone is tired of hearing this story, then I’m sorry. But that post from Jared Kaiser from Bukingham where he bootstrap simulation. So, he took –

Cameron Passmore: That’s the supernova.

Ben Felix: Or the S&P 500 goes supernova is the title of the blog post I’m talking about. But he took all of the monthly returns for the S&P 500 from 1926 through, I think, October 2018. So, all these, these massive bucket of monthly returns of actual historical data for the index, and then he draws a monthly return out. Plops it into a return series and that 116 times. That gives me 116-month return series, which you can compare to the actual returns of the S&P 500 over whatever –

Cameron Passmore: How many of those did he create?

Ben Felix: 100,000 of them. So, 100,000 simulated historical periods that we could compare to the S&P 500 over – Do you have time period there?

Cameron Passmore: Yes, March of ’09 to October 2018.

Ben Felix: There we go.

Cameron Passmore: Roughly that decade.

Ben Felix: Right. So, he took that. Did this 100,000 range of possible outcomes with the bootstrap and he found that 0.57% only, 0.57% of these simulated outcomes beat in terms of risk adjusted returns the actual performance. 

Cameron Passmore: That just happened. 

Ben Felix: That has happened. Yeah. So, I mean, when we’re talking about is this going to continue? I mean –

Cameron Passmore: It’s a truly an extreme event. 

Ben Felix: I don’t remember his exact words, but he said something along the lines of the actual result was almost statistically impossible. His kind of sentiment around writing the article was like, “This has happened, but it’s such an outlier. It’s probably not reasonable to bet on this happening for the next 10 years.” 

Cameron Passmore: If you look at the period before then, from 1970 up until that period. So, that’s a fair chunk of time there, 39 years. The S&P TSX return 9.4% compounded. The S&P 500 did 9.6 compounded, and the MSCIE feeded 9.3 compounded. So, they’re all very similar returns. 

Ben Felix: Most interesting thing about this, and it feeds into our conversation about diversification, or should you just own the S&P 500? Even though the S&P 500 beat those other indexes over this time period ending 2009 or June 2009, if you combine all three of them into a portfolio and rebalanced it monthly, your annualized return increases to 9.84%.

Cameron Passmore: So higher than anyone of those three.

Ben Felix: Correct. And you get a lower standard deviation, which is that is what you would expect from diversification.  

Cameron Passmore: Because you’re rebalancing, selling high, taking advantage of volatility and prices.

Ben Felix: Yeah. So, that’s diversification network. Free lunch. Higher expected returns with lower risk, which is a pretty big argument against just investing in the S&P 500. I think one of the things you mentioned earlier is the correlation and how it’s not that great of a measure. Correlations increase when the market drops. But I found a paper from AQR that was really interesting, 2011 paper. They said that, like you said, when there’s a panic – They said it more scientifically. They said when risk appetites change, which is a panic, prices from all different markets can drop at the same time. But over the longer term – And their argument in the paper is that investors shouldn’t care about short term correlations over the longer term. Markets returns are driven primarily by economic factors specific to whatever country we’re talking about. So their argument is that even though correlations may be increasing, even though correlations may increase in down markets, that’s not a reason not diversify. Which, I mean, it makes logical sense.  

Cameron Passmore: The data in there about the U.S. stock market currently making up 55 per cent of the global market capitalization right now. But that is not always been the case. Incredible data in there. So, was it from that paper that they talked about in 1989, Japan made up 45% of the global stock market?

Ben Felix: No. This is from CFA Institute, published a book on market history a while back.

Cameron Passmore: While at that time, in 1989, the U.S. was 29%. But from January ’89 through June 2019, so up to now, Japanese stocks have returned .61% per year on average. 

Ben Felix: Pretty crazy. That’s before inflation too.

Cameron Passmore: So you just don’t know what can happen to an entire country or region.

Ben Felix: Now Japan’s 8% of the global market. That’s been crazy.

Cameron Passmore: Down from  45. It’s completely crazy.

Ben Felix: Now U.S. is 55. It’s like you can look at that and say, “Well, it’s going to keep going,” but maybe it will. I mean, U.S. is pretty great, but Japan was pretty great too. It is still pretty great, just their stock returns haven’t showed it. 

We’ve talked with the Hendrik Bessembinder paper that came out last year, or is it 2017 maybe? It’s that quote that’s being used quite a bit now at least in our world showing that 4% of U.S. stocks drove all of the returns of the U.S. market from 1926 through 2016 or something. He just came up with a new paper. Did you see it?

Cameron Passmore: No. I didn’t. 

Ben Felix: Yeah. I was pretty excited to see it. So, he looked at global stocks this time. The data, it’s not as long. But from 1990 through 2018, this is mind-blowing. 4% is crazy. 4% of stocks driving all the return. In this case for global stocks, 1990 through 2018, 1.3%, 811 out of 62,000 global common stocks in the study explained all of the net wealth creation in excess of what could have been earned by T bills. 

Cameron Passmore: Mind-blowing. This is why you always make the point about reliability and get safety in numbers. Some people might look at that and say, “Well, our job is to find those 1.3%.” That’s why I always laugh at these high-conviction portfolios that we often see and hear from potential clients.

Ben Felix: If you can pick those 811 stocks, you absolutely killed it.

Cameron Passmore: But people view that as their mandate as supposed to in the framework of a financial plan, “Let’s reliably get you to a successful investment experience.” It’s a whole different mind frame.

Ben Felix: Right. 

Cameron Passmore: That’s the approach we’d take, is better not to blow it than try to be a star by picking it.

Ben Felix: They also found that 61% of firms created negative wealth, destroyed wealth.

Cameron Passmore: Destroyed wealth. 

Ben Felix: Just 49% created – Well, sorry. 39.

Cameron Passmore: 39% created this positive wealth.

Ben Felix: Then 1.3 drove –

Cameron Passmore: But a handful drove all of it.

Ben Felix: Right. I mean, it really is amazing. 

Cameron Passmore: Diversify and rebalance is our main message. Okay. So you have three kids. I have two kids. Our kids are at the different ends of the spectrum. So my kids are drawing down on their RES piece. So, I get real life experience on that end, and you are saving for your kids’ educations. 

Ben Felix: You’ve got to experience on that end to to be fair. You’ve already –

Cameron Passmore: I’ve already saved, but I’m saying that we’ve got current experience on both ends. Saving for years and then drawing down on the other side. 

Ben Felix: We’ve actually had – We get pretty into the weeds with some pretty technical stuff, but we’ve actually had a lot of questions from listeners of the podcast about RESP. It’s like, “Can you cover spending strategies and education savings plans, saving strategies?” Surprising. 

Cameron Passmore: Okay. So the basics; register education savings plan. So you do contributions with after tax dollars. Lifetime limit per child is $50,000. The federal government matches 20% of contributions up to $500 per year. So, if you put in 2,500, they’ll match it with $500, and that money goes directly into the RESP for the child’s benefit. If you have some catch up room to do, you can do double up payments. You can put in up to 5,000 if you have the room and get up to thousand dollars per year of grant. If you want to know what room is available for your child, there’s a super easy 1-800 number to get that information from the government. 

Ben Felix: Super easy. 

Cameron Passmore: They’re very helpful. They’re very good. It’s a very good hotline. 

Ben Felix: But you have to call. For example, we can call on your behalf. 

Cameron Passmore: Correct. So we’ll often call clients in the room and make sure you have their SIN numbers with you. So, lifetime maximum grant that you can get is $72,000. So, if you contribute $2,500 per year, by the time they reach 14-1/2, they pretty much have aged out of the grant. 

Ben Felix: With the grant, right.

Cameron Passmore: So you have to make sure you don’t blow over. So we’ll watch for that for clients to see if they’re no longer getting a grant, then you can decide whether or not you want to continue to contribute up to the $50,000.

Ben Felix: If you start late, to catch up on all the grants, you have to plan to have stopped making contributions, grant matching contributions by the end of the year that the child turns 17. But if they’re 16 or 17, you can only make contributions when they’re 16 or 17. If there’s at least $2,000 in the account prior to that, or if $100 has been contributed in any previous four years before they’re 16 and 17. So it’s not like the deadline is 16 or 17. It’s like you have to have done stuff by the time they’re 16 or 17 in order to get those last couple of years of grant matching contributions. 

Cameron Passmore: I’ve met a lot of people who haven’t saved into RESPs and the kid is like 12, 13, 14. They say, “Oh! I don’t have any extra cash. I just want to do my RRSP.” I’m like, “Well, will you be using your line of credit or some other form of debt to pay for later on?” “Oh, yeah. That’s what I’ll be doing.” “Well, then why not do it now to get the grant? Because the expect return should be as much as your debt is costing, but you’re getting the 20% kicked in. So some people have done that, but it’s just to be where you have to get it going soon enough. So you can’t just backend stuff it.  

Ben Felix: Right. I think one of the biggest hesitations, like I’ve talked to people who are pretty late in the saving game and have never used the RESP. It’s because there’s some perception that the money is stuck or if the kid doesn’t go to school, you’re kind of toast. But it’s actually pretty flexible in terms of what educational programs qualify, but also in terms of what can happen to the funds if the child never goes to school. It’s not a death sentence for the cash. 

Cameron Passmore: Actually, all the RESPs we’ve done over the years, I’ve never seen that happen. 

Ben Felix: I’ve seen a couple, where it’s a different situation, where an RESP may have been started and then the child – When they were like a baby and then it turned out the child had a disability and the RESP in the end can be rolled into an RDSP. That’s a pretty specific situation though. 

Cameron Passmore: We have one that moved to the U.S. So U.S. school that they’re considering may not qualify. 

Ben Felix: Interesting. 

Cameron Passmore: But it’s super easy to take funds out once a child is enrolled in school. They just send in the certificate and you can take out up to $5,000 of the grant and growth within the first 90 days. After that, you can take out as you see fit. 

Ben Felix: As much as you want. As long as you’re still enrolled or even six months after the enrolment period ends. It’s pretty flexible.

Cameron Passmore: There’s no linking to expense. A lot of people think, “I’ll just submit expenses and prove what it costs.” 

Ben Felix: You know where I think that comes from? I think, and this is me – I’ve read this online. How about that? I haven’t verified it. But with the group RESP plans, which are pretty predatory. The CST, whatever they’re called, like the scholarship plan. What those is I think you do have to verify expenses. I think that’s where this comes from. 

Cameron Passmore: Could be, but in our world we don’t. 

Ben Felix: Absolutely! 

Cameron Passmore: Typical self-direct RESP, you don’t.

Ben Felix: Yeah. Just another reason to avoid those scholarship plans. 

Cameron Passmore: In terms of asset locations. So, what I did when my kids are young. I did all equity for the first – I don’t know, 6, 8 years, and then switched it over to 60-40. Then I recently switched it to 40 equity. 60 fixed income. There’s two years left to use it up.  

Ben Felix: One of the really interesting things that I find about asset allocation for RESPs is that when you’re thinking about asset allocation for the RESP, people will often think about the time horizon as being from today until the child enrolls in school. So let’s say from today until age 18. But the reality is, it’s from today – Well, there’re a couple of ways to think about it. If you actually need to use the money in the RESP to cover education costs, the time horizon is from now maybe until they enroll, but maybe until they’re done school. You could take the money out at the enrollment period. 

But the other interesting thing about it is that you don’t have to take the money out and spend the cash on the school. You could take the money out and use some other cash to cover school costs, like your income or whatever, and the money that comes out of the RESP could be invested somewhere else. So it’s not like you’re going to – If you’re 100% equity when your child goes to school, the only that means is that you can take the money out of the RESP in a tax efficient manner, because we haven’t mentioned the grant and growth or taxable to the child as long as they’re enrolled in school. But you could do that and you could take it out while they’re enrolled and then reinvest the money. It’s not like you’re forced to –

Cameron Passmore: Flip it to the TFSA or something. 

Ben Felix: Right. You’re not forced to take the money out and take the loss on an investment that you had in there. It’s kind of like how people think that with the RRIF, when you start taking minimum RRIF payments, like if you have investments in there, you’re going to take a loss if it’s down. No! You can just take the money in the RRIF. You’re going to pay tax on the amount that’s down, which is actually a good thing, right? Because you’re paying tax in a lower amount, and you can take the after tax funds and go and reinvest them in your TFSA or taxable account or whatever. You’re not forced to spend the cash,I guess. 

Cameron Passmore: But many people will be using it to fund their education. 

Ben Felix: Sure. In which case, your [inaudible 00:29:17] more constraint. 

Cameron Passmore: People really don’t like seeing the RESP be too volatile in those last few years before they go to school.

Ben Felix: Oh, yeah! 

Cameron Passmore: That’s mental accounting for sure, but still.

Ben Felix: I agree. It is mental accounting. But you’re right. In a lot of cases what we’ve done, like you mentioned going to 40-60. But for a lot of clients, we’ve built a four-year GIC ladder inside the RESP to match up with their expected education expenses. We kind of mentioned it, but maybe worth talking about more explicitly. If a child never goes to school, what happens? I said the money is not going to disappear, but in a self-directed account. With those scholarship plans, I think the money does disappear, I think.

Cameron Passmore: Yeah. I don’t profess to be an expert on that. But in our world, yeah, it doesn’t disappear. You always get your money back. The government always gets their money back.

Ben Felix: Right. But I think one of the big things that’s pretty interesting is that an RESP can remain open for 36 years. So the child is 18, doesn’t go to school, well maybe they’ll go to school 10 years from now. You can leave the money in the account for a while. 

Cameron Passmore: So many places qualify. 

Ben Felix: Yup. Yeah, I had notes on that.

Cameron Passmore: C-GIPS, trade schools, colleges, universities and other institutions certified by the Minister of Employment and Social Development. 

Ben Felix: Yeah. I looked at that list of other institutions, which is on the government accounted website. It’s pretty broad.  

Cameron Passmore: It really is a no-brainer. You get your money back. Government gets their money back and any growth comes back to you taxable plus Certax, because part of that growth was –

Ben Felix: Taxable to the child.

Cameron Passmore: Correct. 

Ben Felix: Oh, sorry. Are you talking about if you –

Cameron Passmore: Yeah, if you want it [inaudible 00:30:43] taxable to you. 

Ben Felix: If you’re wanting it up. Yes. 

Cameron Passmore: And you pay taxes, because part of the growth came from the grant growth. 

Ben Felix: Tax plus 20% penalty on the growth. 

Cameron Passmore: Yeah. 

Ben Felix: But you can also roll up to $50,000 of the gains into your RRSP if you have room.

Cameron Passmore: If you have room.

Ben Felix: They’ve made it pretty flexible. With a family plan? Instead of having like an individual RESP, if you have both of your kids or multiple kids, like I do, and you’re in a family plan, then all of the growth can be pulled together. So, I’ve got three kids. If one of them goes to university and two of them don’t, all of the investment growth from the contributions and from the grants earned by the two kids that don’t go to school, all of the investment income can be used by the third child that does go to school. 

Cameron Passmore: You just can’t share the grant. 

Ben Felix: Each child can only take out up to the maximum 7,200.

Cameron Passmore: Correct. But if you maximize for the three kids, the third child can’t use the other two siblings’ grants. 

Ben Felix: Exactly. I think one of the things that’s needed to talk about is a t rick that a lot of people don’t realize is the RESP super funding, which we often do this for clients that if you have the cash available. But what super funding means is the – So, Cameron, you’ve mentioned the $50,000 lifetime contribution limit. We also mentioned the $7,010 in maximum grants that the government will give you. To get those grants by age 14-1/2 like you said, if you do the 2,500 a year, you will have put $36,000 into the account.

There’s $14,000 of contribution room. So, 50,000 minus 36,000. There’s $14,000 of  contribution room that will never attract a grant no matter what. So you can take that 14,000 and you can just dump that into the account today, and it can start growing tax, whatever you call it. 

Cameron Passmore: You just have to make you don’t blow over your limit, because then penalties will come up. 

Ben Felix: Right. 

Cameron Passmore: So you have to be careful. But if someone’s detailed enough, there’s no problem.

Ben Felix: The other interesting thing that we looked at a while ago was what if you just took the whole 50,000? Forget about the grants. 

Cameron Passmore: Just do it when the child is born.

Ben Felix: Just do it when the child is born. We modeled that a while back, and I can’t remember the expected return that we use and I didn’t redo the model for our conversation today. But the fundings that we had then were that the expected outcome was almost identical with dumping the whole thing in versus super funding and then maximizing every year. 

Our conclusion to continue super funding as supposed to dumping it all in was driven by the fact that the $50,000 lump sum fully relies on market returns. Whereas the super funding and then annual grant matching contributions, you’re relying on market returns, but you’re also getting the guaranteed grab boost. 

Cameron Passmore: Plus people like in the grant. There’s a huge behavioral bond there too. But if the government grants going to make it more reliable outcome, why not do it that way?

Ben Felix: Exactly. Anything else that you had for the RESP?

Cameron Passmore: No. I think that’s good for the RESP. The bad advice of the week – I mean, we don’t really have a topic for it, but you have a video coming up again that is going to bring out all your friends, your dividend friends.

Ben Felix: So, someone sent me a video on Reddit, whoever that was. Thank you. Obviously, Reddit is anonymous, except me, because I use my real name on there. But someone sent me this video of a dividend investor from the U.S. who made a video about dividend investment and has used me, like my video about dividend investing as their sort of intro. Then their video is a rebuttal against what I had said. 

Hearing people talk about factors – This guy kind of said, “Yeah. It’s kind of interesting that there could be other factors other than dividends that are explaining these returns.” But I can’t remember what he said actually, but he had some sort of non-evidence based rebuttal. But it’s like it’s really hard to look at something like factors, which are the workhorse model that allows us to understand how financial markets work. It’s kind of crazy to me to look at that and say, “Yeah, some people might look at the market this way.” But it’s like, “No.”

Cameron Passmore: : This is how professional academics look at the data. 

Ben Felix: And it’s how the market works. These models are the models that we’re using, because they work. It blows my mind.

Cameron Passmore: If you want to compete with it, go publish a peer-reviewed paper 

Ben Felix: Right.

Cameron Passmore: Go toe-to-toe with Fama and French and these people. 

Ben Felix: Show me the model. 

Cameron Passmore: But seriously, you can’t just turf academic research like it’s some bunch of quacks in a think tank somewhere, like jump in, compete then.

Ben Felix: Without data, you’re just another person with an opinion. The other thing that this person said – Oh! I was going to say to with Fama. Fama said to Thaler, or Fama told us when he was speaking to a group that I was with that he says to Thaler that until Thaler has – Thaler’s behavioral economics, right? Richard Thaler. Both Noble prize winners, right? Fama tells Thaler that until Thaler has a model, EMH is the only like –

Cameron Passmore: It’s pretty funny.

Ben Felix: There’s no behavioral explanation for anything until you have a model. I have a model, therefore, efficient market is the explanation, or the five factor model is the explanation. So I got more thing in this dividend thing. 

So the guy said in the video that companies that pay dividends, it puts sort of pressure on management to be really responsible and make good management decisions so that they can keep paying their dividend. It also forces and to focus the business on cash flow, which is going to lead to good stock returns. 

Cameron Passmore: It’s a great story.

Ben Felix: Man! Stock returns? What explains future stock returns? The price. That’s it, the price. If the price is low relative to whatever, relative to book, relative to profitability. If the price is low, then your expected future returns are higher. But that has to be in the price. 

So the idea that good management practices are going to increase stock returns, all that means, like what you’re saying by saying that, my dividend investing friend, what you’re saying by saying that is that the market has mispriced these stocks. So we’re saying that dividend paying companies have better management practices, but the market doesn’t realize that. That’s what we’re saying by saying that dividend stocks with good management policy are going to have better future returns. We’re saying the market is mispricing them, which is, I mean, sure. That’s a tough argument to make though, I think. 

Cameron Passmore: I’m nodding. For those who can’t see, which is everyone, I’m nodding in agreement. 

Ben Felix: Oh, I’ve got one more on that. So, the other thing that – This has been twice now. There have been two sort of – The people that created these sort of answers to my dividend investing video, they both got a ton of views, a ton of comments. So people are watching them, which is interesting. I think it’s good that it’s creating the dialogue. Same is that globe mail article. Remember that? That got a ton of engagement too. 

Cameron Passmore: It’s actually fun to read all the feedback, and some of the people comments and how they take pot shots at you, it’s actually quite entertaining reading. 

Ben Felix: So, two of these guys – I mean, both of them have pretty big followings of their own, but they both said something that I found just fascinating. They both said something along the lines of, “I don’t know why this Ben Felix guy is taking shots at dividend investing.” You go to talk what index investing, but we’re going to go talk about dividend and growth investing. But they’re both totally find approaches to investing. They’re both just as good as each other. No one’s better than the other, and people should do whatever they’re comfortable with. 

It’s like, “No!” There is a statistically reliable way to do things. If your is retirement, statistically, reliable retirement outcome, there is a right way, or at least a most reliable way to do this. It’s not like, “No! Do whatever you like. Do whatever you feel comfortable with.” No! I mean, that’s now how I view it. Sure. If other people want to do it, they’re comfortable with it, but they should be doing that with the understanding that what they’re doing is not reliable. It’s kind of like the rent versus buy decision. Sure, you can buy, or you can rent. But you should be making that decision on the basis of the financial outcome being the same either case depending on the numbers. Well, everybody, Ben is back. Ben’s fired up. I’m sweating, but it’s because this room we’re in is so hot. 

Cameron Passmore: All right. Thanks for listening.  

Links From Today’s Episode:

Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.
Rational Reminder Website — https://rationalreminder.ca/ 

Shop Merch — https://shop.rationalreminder.ca/

Join the Community — https://community.rationalreminder.ca/

Follow us on Twitter — https://twitter.com/RationalRemind

Follow us on Instagram — @rationalreminder

Benjamin on Twitter — https://twitter.com/benjaminwfelix

Cameron on Twitter — https://twitter.com/CameronPassmore