Pooled RESPs are not perfect but should still be considered by parents

Now for something boring - but relevant.

As a former member of the financial services fraternity, a piece about Registered Education Savings Plans (RESP's) in the business section of the Montreal Gazette - Montreal's only English daily of decreasing repute to some - caught my eye.

While many investment products are far from perfect, some do actually provide decent benefits. Registered plans (tax-sheltered investment vehicles) have their merits and demerits but as an overall concept, it is difficult to dismiss the financial advantages - provided of course if sound investment principles are applied. Nothing is written in stone and precious little (except for government backed securities) is guaranteed. However, pooled RESP's give investors another option to the already available self-directed education savings plans.

The concept is simple: An investor sets money aside on behalf of a beneficiary to be invested in the plan in a pooled investment - ie, all the monies are put together. The mandate of the money manager is to conservatively invest the funds to ensure that the plan provides safe and sufficient payouts when the beneficiary is ready to go to school. This is accomplished by essentially investing in high-quality government and corporate bonds.

RESP's are for families who are prepared to stay in the plan over the long haul - up to 25 years depending on the beneficiary. While it is impossible to know if a child will end up in University, the plan does offer options in the event that a beneficiary does not go to school.

The biggest knock against these plans is the rigidity and the "hidden" fees, and this is the main focus of the article. To hook people, the trick was to find disaffected people who were unlucky enough to have been provided with poor service. Does this mean that RESP's are stained? Of course not.

Pooled RESP's do remain more rigid than most plans; however, they are not as bad as they are thought to be. With proper explanations, parents should be well aware of the way it functions. Indeed, pooled plans have become far more flexible in the last ten years and will probably continue to evolve moving forward.

Such investments are unlike mutual funds in that money managers are used to actively trade stocks and dealing with the constant inflows and outflows of cash (withdrawals, deposits etc.), pooled managers on the other hand rely on stability. They need to have a more predictable process in order to provide a) preservation of capital and b) ensure that payouts are available when needed.

As for the fees, there are "hidden" fees in almost anything in the investment world. All fee calculations remind you that your math skills are below average. Regardless, by law (and Canada absurdly has no national standards) all companies are required to disclose their fee structures. I read the CST RESP prospectus. It is clearly spelled out and I know for a fact that representatives are concious of this fact. If you find that your rep is not answering your questions satisfactorily there are options for you. Either ask to speak to someone who knows or simply ask for another rep. Someone will be able to help you.

We live in an imperfect world, and believe me financial services has its problems, but investors deserve much, much more than these "investigative" pieces that stink of ulteriour motives. Or maybe the media is just bent on finding any negative hook they can find to sell their crummy papers.

Here are some excerpts in the article (there is no Internet links to it so you'll have to trust me on this one. I am your Virgil on a journey into the Inferno....cough):

Referring to one of several "pressure" tactics used by RESP representatives, the author writes, “Did she know tuition costs are exploding?”

Salespeople can be pushy. We all know this. However, sometimes you need to go past the messenger and listen to the message. Predictable as this piece may be, it would have been only fair and simple to pull out figures published in Statistics Canada. Tuitions costs are rising. The fact that the median household income (to say nothing of socio-demographic and economic considerations) in Canada is around $50 000, this may not be enough to offset tuition rises.

Moving on to another interesting but perplexing quote. “The plan’s low-risk investment strategy wasn’t giving the returns she was seeing in the recovering stock markets.”

It makes a person wonder how a writer in the business section would miss the opportunity to correct a glaring misplaced rationale in the above statement. The plan does indeed have a low-risk investment strategy and a casual gloss over of the prospectus will show how this is achieved: it invests in bonds. Bonds do not outperform equities. But they do provide safety of capital. That's your trade-off. With this in mind, the appropriate comparison is with what the bond markets are presently (and historically) rendering. It’s the proverbial comparing apples with oranges. Or for you sports junkies, would you compare one athlete to two other athletes from two different sports to decide if you want to select them? Of course not. It's misleading. You'll look like an idiot. Who's the GM of the Hamilton Tiger-Cats and Detroit Lions anyway?

“She thought they could do better investing her education savings themselves.”

In rising markets don’t they all? I remember during the market rise just before the bubble burst in 2000, newspapers were publishing articles that alleged monkeys were just as effective at outperforming the markets as the experts. They were advising people to fire their stock brokers since they too can do it on their own. After all, you are smarter than a primate....right?

Jokers they were. Who were they kidding anyway? Professional money managers put in 80 hours a week attempting to match or outperform the stock markets over a long period of time. Last I checked, no monkey ever lasted as long as Peter Lynch or Warren Buffett.

What makes people with precious little time or expertise think they can do it?

About the fees and under performance, “She asked for her money back.”

This is not a product that can be easily returned to a Wal-Mart counter. Pooled investments are predicated on a stable investment inflow. Managers are passive in their approach in that they are not actively trading bonds like you would see in a stock-based mutual fund. A stock mutual fund manager (depending on the strategy and mandate) is constantly attempting to outperform the markets.

Should an investor ask for their money back if their mutual funds drop in value? Go ahead. Try it. You'll be poorer for it. While in some cases cutting your losses is smart, on average attempting to chase "returns" is a bad move. Especially if your expectations are unrealistic and unclear.

This is a classic myopic outlook that completely disregards the long-term benefits. An RESP is truly just that - a long term product.

“They were really good at spinning it so you don’t focus on the fees.”

Possibly, but misleading nonetheless. When it comes to investment products, it’s hard to find an investment without mercurial fees. Mutual funds are just as complicated. At least the pooled RESP returns the enrollment fee. The return of that fee may seem complicated but it is clearly stipulated in the prospectus. As a business writer, did the author and/or the editor read the prospectus?

There is no doubt that there are poorly trained salespeople. However, this takes place right across the financial industry at large. Efforts are made to ensure that salespeople are made aware of the rules, regulations and proper sales practices. Is the Gazette itself, for example, free of shoddy reporting?

When it comes to getting a quote to legitimize a thought, it is popular, if not the norm, to seek the opinion of a financial planner. “I would never recommend these plans to parents. Never.”

Well, that’s his opinion and this should have been matched with someone who would. Suggesting that people invest in mutual funds in a financial institution is somewhat disingenuous when you consider:

-Most are self-directed and most people are not sufficiently experienced enough to build a proper mutual fund portfolio by themselves.
-If they are not self-directed, they have to be lucky to have a caring banker who is knowledgeable enough to invest the money properly. Not all bankers are. Besides, the turnover at the bank is high and people would have to put up with meeting a new banker every six months. Not a good way to build trust - especially when there’s a market correction that may negatively impact an improperly balanced portfolio.

“I prefer things that are simple and have flexibility.”

Don't we all? Mutual funds have high Management Expense Ratios (MER’s) and are far from simple. If anything, they tend to be far more complex in that you really have to know what you’re doing to invest in them. A conscientious investor will try and keep this in mind and will try to find investments that offer low MER’s but the fact is that most are high. Don’t forget, the bank wants to sell their funds and the choice of high-quality bank funds are rare. Once past, Royal Bank and TD, the bank investment world is a dark forest. Banks still can't sell third party funds. In other words, you can't buy the really good ones that are available.

MER’s tend to erode returns over the long term and this most investors will not tell you. Furthermore, back-end charges tend to be extremely high and make mutual funds rigid (though if properly planned mutual funds can be flexible) in themselves. For example, if an investor wants to sell an underperforming mutual fund, they may not be able to do so if the deferred sales charges are too high. The only other option is to transfer within the same family of funds.

However, what happens when there are no suitable alternative? Yes, they can buy front-end (which is probably the best thing) but read the prospectus. The “hidden” fees are all there to read.

Above all, mutual funds are popular from the financial planners and stock broker perspective because of the trailer fees paid to them.

This is all beside the point. Mutual funds have their legitimate place in a stock portfolio and many do offer solid returns. However, for risk averse people (and the profile of the people interviewed in this article struck me as people who would not be able to handle market volatility) mutual funds may not fit their needs.

Yes, there are conservative funds but again I ask: do you have the time to pick, choose, follow and deal with all that? I'll answer this: no. Very few do. Pooled RESP’s have a completely different mandate than mutual funds. They may have some inflexibilities but as an investment they offer far less volatility (and peace of mind) over a long period of time.

“Another concern is that group RESP plans tend to invest most of their assets in conservative fixed-income holdings. Such investments are less risky than stocks but provide lower returns.”

Let’s keep perspective here. Among its stated objectives, the goal is to ensure RESPs do not lose your money. Your trade-off is indeed lower returns but at least your CAPITAL is PRESERVED and eventually RETURNED. Ultimately and equally as important, your child has a nest-egg to draw on to attend a school.

Why is this a concern again?

I have a question of my own. Do most Canadians really need a financial planner? Here in Quebec we have an average household income of $40 000. How does this justify paying a financial planner for a service they do not really need?

The odd part of the article is where the author writes:

“…average returns ranged from three percent to seven per cent annually between 2002 and 2005…That’s compared with an average 11 per-cent annual gain by the S&P/TSX composite index…”

Last I checked the TSX was a composite of actively trading common stocks. Does the author feel we should compare preferred stocks with the TSX as well? The plan, as already mentioned, does not invest in stock so this was an absurd comparison.

And so ends an overall disappointing “assessment” of the shortcomings of RESP plans. A little more depth in the right areas would have hurt no one – assuming that the purpose was to truly educate and enlighten readers.

In a nutshell, the article argues people should not purchase this plan – despite significant positive strides in recent years - because of complicated fees, rigidity and low-returns. Personally, I would have used an entirely different approach to present a more balanced point of view.

The overall benefits of pooled plans, however imperfect, fall in favour of the conservative and disciplined investor and ultimately the beneficiary over the long-term.

Note: Image from vancouverdad.com