I had so much pain over the biggest financial mistake I made (so far), that I had to write this, just so I can relax. I guess it's sort of how psychiatrists make you talk about your negative experiences in public, so you can get over them. This deals with my problems involving USC RESP and Heritage RESP.
Here's briefly what I went through:
- After I understood the implications discussed below, I (as painfully as it was) decided to transfer what I could salvage to a self-directed plan with a major institution, where I manage them together with the other savings (RRSP, non-RRSP, mortgage whatever). All said and done, I lost $6,000, or more than half of what I managed to set aside for my kids over 4 years, to gain freedom and set things right.
- It took 3 months, many phone calls and a lot of hassle to get USC RESP to apply for and receive my government grant, because they did not do so for any of the past 4 years…even now they cannot tell my why they did not get the grant, as they were supposed to. The CESG officials say it's because they did not apply. If I hadn't checked, I would've woken up 15 years from now with no grant and no interest on that grant…loosing in effect tens of thousands of dollars.
- It took a lot of reading in detail of their annual statements, prospectus and stuff about investing, to decide these plans were bad for me. I'd like to think that in the future I'll spend way more time reading any small print I adhere to and understand it in detail.
- I sent complaints to the OSC (Ontario Securities Commission) about the lack of disclosure in their promotional material, as well as deducting the fees even after failing to apply and receive the government grant on my behalf. Given their target market (new immigrants and new parents which are generally young and/or inexperienced in saving and managing money etc) I think the lack of disclosure is relevant. I later learned that these are very common complaints and OSC has long been after these group RESP plan promoters for bad sales practices and even have setup a warning web page (http://www.vaninvestor.com/You/RESP/OSC_RESP_condition.htm).
And now the long story, including my thoughts and why I ended up doing as I did.
First off, I have no special training and I am in no way qualified to give any advice regarding financial or any other family matters. The purpose of this is to detail my negative experience with the group RESP plans and express my own thoughts regarding education savings for our kids …and you're constitutionally free to take them at face value or disregard them as irrelevant (which they in fact may be).
To start with, I gather there are two types of plans for education savings in Canada: self-directed plans and group plans. Four years ago I didn't know this and, convinced that I need to save for the child's education, gave in to a sales rep's push to sign up with a group plan, USC RESP (Protégé RESP at the time), although the over 3,000$ in early termination fees seemed a lot. I didn't realize (or spend the extra time to look into it) that there are other options. I thought that was the only way to benefit from the governments' grant and thought that the "just so we make sure you don't withdraw the money and drink away your child's future" sales rep's argument for those fees sort of made sense.
Two years later, none the wiser, I thought I'd diversify and opened the plan for the second child with Heritage RESP, known as Allianz RESP for a brief period.
The dumbest mistake I made here was to get locked in with the 3,000$ early-termination fees. Maybe it makes sense for some people that have serious money issues and drinking or gambling problems, but I had neither and, just as I don't need a breath analyzer mounted on my car to keep me from drinking and driving, I don't need a 3rd party's imposed penalties for changing my mind, especially when, as I realize now, there's no real benefit to me from the plan. Mind you, these fees apply even if that plan proves stupid and underperforming and you decide to transfer it to another institution, which is what I ended up doing…
I did not notice initially (figure how dumb one can ever be) that the fees were deducted at the beginning of the plan, i.e. 50% of your savings go to these fees. That's a pretty good way to "lock" someone in. The other plan, Heritage RESP, was even worse: at the end of 2 years you end up with 3/4 withheld for fees (3k out of 4k saved). What's worse, you don't earn any interest on those moneys! They do!
Why do I keep saying "locked in" is because normally, one (almost everyone I talked to) would not withdraw their money and loose this much, even if the plans prove bad or underperforming. Mind you, this is not the same as a back-end load mutual fund. That mutual fund would be just a part of your portfolio, while this RESP is your entire child's education savings.
The second dumbest mistake was not wanting to manage my savings nor paying attention to how my money is invested. Again, maybe it makes some sense for folks with no retirement savings nor plans to save in any of the next 10 years, but otherwise, the thought was plain dumb. One simply has to take a basics course in investing, just like you learn to drive a car or learn basic mathematics in school. A car will cost you money and possibly health or even your life, while savings will (generally) make you money…which deserves more attention?
- It is true what it's being said that most people spend days or weeks researching, learning, studying and comparing before buying a $2,000 wide screen TV set, while spending no more than 20 minutes listening to a sales representative and buying a $30,000 plan. Well…it was true of me, anyhow. What about you?
- In my case, not having any savings at the time, but plans to start saving in the next 10 years, at some point in the near future I would have had enough to start worrying about it and there's no point handing over what will be a significant part of my savings to a "locked in" plan, managed by someone I don't know.
- Today, we have some savings (retirement etc) and I simply have to manage them. One can either learn a lot about it and go at it by one's self, or hire an investment advisor that one can trust. Either way, there was no point giving the money away to someone I didn't know, "without" even the option of freely transferring them elsewhere. Also, even if I was planning to get an advisor, I should have understood some basics, so I can have both reasonable expectations and an intelligent conversation with the advisor.
It's actually a shame that the curriculum in high-school did not include any financial planning elements.
How do they invest the money? Into bonds … and mostly government bonds, at that. How should one invest his own money? Any investment article, course or book will tell you to invest in a mix of stocks and bonds. Disclosure from their part? None.
Other sales rep arguments that appealed to me at the time but don't really make any sense, as I later realized:
- Projections at a return of 8%. This is what the sales rep said the current expected long-term return is. Well, besides the fact that USC in the past 4 years since did about 5% rather than 8% (as I found out when I actually bothered to read their annual statements for the past couple of years):
- The 8% is based on the (not long, but) huge term return of bonds over the past 100 or so years. However, they're bound to do worse or better than the average in any time period (say a decade or two).
- One actually has to look at real returns, not nominal returns, as inflation reached 12% and more in the US in the recent decades. What does that mean? Getting 8% interest in a 12% inflation environment means you're actually loosing 4% each year. Currently, most central bankers target a 2% level for inflation, so…in my mind, there are very slim chances that long term returns from bonds going forward will be anywhere near the past.
- Using the same metrics, stocks returned 10-11% over the same period, so…why is 8% better? Obviously stocks are more volatile and riskier over the short term, however, even with the market flat, if you constantly invested a given amount (cost-average, say monthly) you ended up with an average compounded 8% return between 1930s and 1950s, see "Intelligent Investor" by Ben Graham. Any investment advisor worth his/her salt would recommend a mix of stocks and bonds (and other assets), so you're exposed to both the possibility of higher returns of stocks and the lower volatility of bonds.
- Now, when interest rates are at all-time lows, bonds have very good chances to under perform their historical averages over the next few years. Interest rates have little options but to go up, so total returns from bonds have little options but to go down (kind of tricky to understand this – read a good article on bond valuations to get the picture).
- To be accurate, stocks face the same hurdles. Given the rich valuations present today, many professional investors expect 6%-7% returns in the next decade or two. Would bonds give a better return? It happened, so why not…it doesn't make any sense, though, once you understand the difference between them.
- USC RESP's allocation is tilted heavily towards government bonds, which return less than other bonds (corporate). The average 8% return quoted for bonds does not come from such a bonds allocation, but a more aggressive one…so their projection was basically a flat out lie.
- "Guaranteed" bonds. These plans invest only in bonds, government, municipal or corporate and are marketing that as a "safe" way to invest. Actually it's stupid for me or anyone to be limited to bonds. Over the long term they are no safer or riskier than any other asset class and, given the short time horizon (say 7-10 years in which you're looking at a meaningful amount of money in the bonds-based RESP), they can do better or worse than any other asset classes.
- Often they're said to be inversely correlated to stocks, so if stocks do well, bonds are then bound to do worse.
- It may in fact be riskier to be subject to bonds only and not diversify across other asset classes, such as stocks. So a claim that bonds are safe is false. Plain and simple false…another lie. A properly diversified asset mix will be safer and yield more for the risk than plain bonds.
- Education costs are rising at about 6%.
- One must understand that there is no generic risk, only specific risk. When saving for something, say education, some specific risks I see include the risk of not earning the optimal return for the given time horizon. I mean if I'm saving money, why not save them properly, at an optimal return.
- Fine, you like bonds? There are many options…many good bond funds, especially those managed by large banks for instance (TD or others) with reasonable fees (1% or less). They did better than USC RESP for any 1, 3 or 5 year period for instance and there's no reason to believe that the USC advisors are better than, say, TD Bank's advisors, is there? If there is, let me know.
- "non profit organization". Really???
- There are employees, managers, investment advisors, board members etc. They all get paid and I have not seen an iota of disclosure about what the bonuses and salaries really are.
There are sales people that get commissions, vacations and boat cruises. Again, I never saw any disclosure about the sales commissions and incentives. - As long as someone does not volunteer but rather gets paid for services, I cannot consider the said services as "not for profit".
Can I ever be dumber? Not likely, but unfortunately, quite possible.
Recently, I started paying attention to how my savings are managed and my options were:
- Get an investment advisor.
- As it turns out, the better advisors out there are not interested in managing small accounts, so I have to wait and save for a while.
- Other advisors are charging fees in different structures, none usually tied to their own performance, so I'll pass on those.
- Get investment advice
- Go to my bank and get investment advice there. They will give some, even free of charge, just to get "my business".
- There's loads of it all over the internet these days. Two very good sites I ended up subscribing to are www.morningstar.com (there is awww.morningstar.ca as well, but not much advice there) and www.fool.com. Both have investment seminars and courses which you can read, about investing, saving for retirement, education etc. Some are free while some (presumably the better ones) are available for a fee. I got the free ones, of course.
- Go at it alone. Not having enough to interest a better advisor (one that has a good track record etc) I ended up going at it alone, with a mix of funds, bonds and stocks. However, I would not recommend to anyone to do it unless you understand in depth what it is you're doing and are ready to commit quite some time and effort to it. There are many levels of involvement, from passive index investor to full time day-trader (I am neither…or in between, heh).
Back to the group plans.
From what I understand reading up tons of government publications (not the easiest thing to read), normally, with RESP plans, you can take your principal back when the plan matures. If the kids do not go to an approved institution, then you can transfer about 50,000$ more to your RRSP, subject to some conditions. The rest must be given away to your institution of choice.
For the many drawbacks, these group plans have approval to redistribute the amounts not used by some students, to the other students in the group plan. Likely that's why their named "group plans". And of course, they tout it as a huge advantage or a self-directed plan. So, is it an advantage? I don't think so:
- The way these plans are structured, if one's child doesn't go for higher education, the parents can switch to an "individual plan" in a window of several months before maturing and then be able to do the same 50K withdrawal.
- If the unfortunate parents did switch and took out the 50K, you're betting that the plan actually made more than that. Indeed, based on their sales people projections, you'd have about 70,000$ left in the plan around the time it matures. You take out 50K and the rest, you unfortunate parent, don't really care if it goes to an institution or other kids, right?
- Except, that projection is based on the long-term return of 8% on bonds (before fees) in the past 100 years or so. Remember, they can outperform or under perform for any 10 year period and, if you subtract some management fees, I'm not sure you'll find a meaningful amount of money left in there and, whatever's left will be distributed among all the children in the plan at that time.
- So, the only option left is that you're planning to profit from those that saved all their life and the kid(s) didn't go to school…plus, they forgot to switch their plans in that narrow window and now can't take anything out but their original contribution.
- Oh…that's right. If you do not switch your plan in that very narrow window of several months before your child's 18th birthday, you'll loose every penny of return. I'm sure the salesman emphasized that, right? Are you compensated for that risk?
One thing to understand about investments (of any kind, including a group plan) is that you must thoroughly understand the risks involved and the rewards and make sure that the probability-weighted rewards more than make up for the risks assumed.
So, to sum up the risks and rewards I'm looking at here: I locked my self in with $3,000 penalties, imposed even if I decide to transfer to a different institution. I have to be sure I send them registered mail within a window of several months of maturity in 18 years, to take full advantage of the plans. I have to hope that a lot of kids in these plans will not go for higher education, so there will be a lot of money available for the plan to re-distribute to me. I have to pray that their advisors will do a better job in the future than they did in the past, when they severely underperformed the average for bond mutual funds, despite getting paid. I have to pray that their "guaranteed" bonds will return enough to cover at least the 6% that education costs are rising by.
Oh, lest I forget, one last point, but a relevant one. The $3,000 are actually deducted at the beginning of the plan, so I won't directly benefit from any interest compounding on my money for the last 12+ years of the plan, when it actually matters. That kind of fee is pretty much unheard of in the world of mutual funds. Even with front-end charges of 10%, what this looks like (I don't remember any fund that actually charges that much), I can get other benefits, like smaller ongoing fees etc. So, even if I stay in the plan for the 17 years, instead of this $3,000 to triple, like the rest of my money, they shrink to less than $2,000, thanks to inflation. Wow, I just lost over $7,000 just to sign up. Cool deal!
So, do the rewards (I don't really see any) above compensate me for the risks I take? NO WAY, in my mind. Which goes to prove that this is not a sensible business setup, but a scheme so some people (employees, board members, advisors, salesmen etc) profit from others, by pushing a product that doesn't make any sense in today's environment.
Does it make financial sense to switch and loose the $3,000 per plan? Yes, if one can produce an average return of at least 0.3% more. YES, that's right, only 30 basis points more. That's how important compounding interest is, see the Excel spreadsheet example. Compare the average bond fund return for the past 5 years (7+ %) with the one they generated (5%) and that's a no-brainer. If, however, stocks return 2% more than government bonds in the next 14 years (they returned about 10-11% vs 8% for a mix of bonds in the past 100 years or something) then just take a look at the table below:
| Initial gains/interest-producing Amount | annual contribution | years | return | inflation | Add back present value of non-productive fees | Present-day value of final amount | Difference: |
Continue and don't "loose" | $ 6,000.00 | $2,000.00 | 15 | 5.0% | 3.0% | $ 1,899.75 | $ 50,351.01 | $ - |
Transfer and "loose" | $ 6,000.00 | $2,000.00 | 15 | 5.3% | 3.0% | | $ 50,633.39 | $ 282.38 |
Transfer and "loose" | $ 6,000.00 | $2,000.00 | 15 | 7.0% | 3.0% | | $ 64,833.97 | $14,482.95 |
| | | | | | | | |
Drawback: 3,000$ lost now are from my principal, not gains (I can't withdraw that at the end of the plan, must pay it to my son) |
I may have messed up the return/inflation calculation, but the numbers seem to make sense. About the table above:
- The initial gains producing amount is without the fees, because these fees are already deducted today and will not produce anything. I would simply receive them at the end of the plan, no interest or gains on them, but after inflation took away 1/3rd .
- Inflation works by reducing the purchasing power of money, so, a given amount of money will decrease in equivalent buying power, each year, with the inflation. That's how it wipes out 1/3rd of the fees which you get back in nominal dollars. Just see it for yourself:
purchasing_power_in_todays_equivalent = todays_amount * (1-i)^n or, in Excel: "todays_equivalent=todays_amount*power(1-i,n)" where - i is the inflation rate (say 3% or 0.03)
- n is the number of years.
- Taking into account the annual contribution will complicate this a bit, but generally, this formula applies when calculating the gains:
Final_amount_in_todays_equiv = todays_amount * (1-i+r)^n, where - r is the nominal (i.e. not inflation-adjusted) rate of return you expect
- Here I discounted back using the inflation. For a correct result though, given that the purpose of the amount is not buying groceries, but paying for education, we should redo the calculation using 6% instead of the 3% inflation. The impact of the extra 3% will scare you (It scared me, really). What this means is that if I don't get more or less 6% nominal return, I'm running the risk of barely covering the first year's fees at the end. Think about it: you deposit $2,000/year, which depreciates at 3% inflation. The costs of schooling rise by 6%/year. You get 6% return on the money. At the end, you're left with less than I put in, in equivalent school-value.
Among other things I learned while reading about investments, which may not be obvious, but certainly are useful:
- Most people are guilty of "mental accounting" and think of the different "accounts" as different things when, all in all, every asset and liability you have should be treated equally, as parts of your overall "balance sheet" and your savings managed identically, with maybe some differences due to their respective time horizons.
- By that I mean that the RESP plans are just a way the government encourages people to save for education. The 20% grant and tax-free status of gains are the main attractions
- You, when the time comes, will have to provide for the child's education, regardless if the money were saved in an RESP, tapping your RRSP, taxable investments or renting your house to others.
- Do not expect high returns in the next decade or two from any generic asset class (bonds, stocks etc). If someone guarantees or promises you a long-term return of more than 6%-7%, send his name to the OSC.
- This is not to say that there aren't entities (companies, mutual funds, advisors etc) out there that can earn more. Some have earned way more than the averages for a long time and chances are they will continue to do so. Those that earned consistently below averages for a long time will most likely continue to do so. Note that 3 years is not a long time…I'm talking 10-15 years or more.
If you don't have any savings and don't plan to save anything in the next 10 years, may I remind you that your child's education is your responsibility and, if you don't build up some savings, be it RESP, equity in your home, RRSPs or otherwise, not only will your children lack higher education, but earn a lot less than they would otherwise when you're old and may need their support.
A final word. You see that most of my beef here is with USC RESP and I only briefly mentioned the other one, Heritage RESP (or Allianz RESP). Heritage's published returns were much higher than USC's, so they may in fact know what they're doing and offer some value for the fees and headaches. Their customer service and my overall experience with them was also a lot better than USC. About the performance, you must understand that the recent 4 years or so were not normal, given the falling interest rates (during which time actively traded bonds give much higher returns than they normally do). Problem is, at the end, you're left with lots of bonds at today's rates (4-5%), which can only go down in value as the interest rates move up…so, the jury is still out on whether Heritage's massive returns were due to skill, luck or a short-term aberration.
Some resources on the internet:
At the very least, make sure to read carefully the Ontario Securities Commission's RESP brochure, see address at the bottom.
General investment/financial links I found useful:
http://www.investored.ca/
http://www.morningstar.ca
http://www.morningstar.com/
http://www.fool.com
http://investopedia.com
RESP stuff:
Among the common complaint areas for the OSC, here's one:
Registered Education Savings Plans (RESPs) - Understand what you're getting into. Read the OSC's Saving for your Child's Education to understand the costs, conditions and cancellation policies of all RESPs.
FAQ.
Answers to some assertions above.
Why are bonds not safer than stocks? After all, they are guaranteed by a government or backed by some assets that were pledged etc.
Wrong. Not all bonds are created equal. The "safer" the bond, the less it pays. Many corporate and even foreign government bonds have been plagued by defaults. So, not safe.
You think US government bonds are safe? Think again. US dollar revaluation down doesn't sound the same as "default" but it has a similar effect: you loose principal. Not in actual dollar amount, but in buying power. You don't save money to have nice statements from your bank, but to buy stuff (i.e. education) in the future. Not safe.
What do you mean by safe, anyway? You will not loose your principal? Maybe, but not earning a reasonable return is not safe for me.
Inflation is the bond killer. Inflation eats away the buying power of money, so even if on paper you have the same amount, it buys less than it did, so in effect you lost moneys. Bonds are not protected against inflation, so when inflation hits, your principal starts going down the drain. (There are special inflation-protected bonds, but this discussion is about bonds in general). Stocks on the other hand generally offer an embedded inflation protection: prices go up and so do profits, hence stock prices. Bonds – not safe.
So, why not buy stocks only?
Volatility, for instance. Stocks may do better or worse in any time period. If they happen to perform poorly by the time you need the moneys, you'll have to sell at a loss. Bonds help by being inversely correlated and reduce overall volatility.
NOTE: the links above for the OSC's brochure don't work. They have toned down the brochure since. The new link is: https://www.osc.gov.on.ca/Investor/Resources/res_resp_en.pdf
Also, read more here:
Cheers.
