Why do people tend to invest money, instead of say, just parking it in a chequing account or storing it in empty yoghurt containers in the freezer? It’s in the hopes of getting a higher rate of return, of course. When you invest your money, whether in stocks, bonds or other investment products, that money has the potential to grow. Now you may be thinking, what potential? We’re in the middle of a market downturn! But the thing about RESPs is that they’re longer-term investments, so there’s time for earnings to bounce back. Let’s start with the basics.
In simplest terms, the rate of return is the percentage that your investment changes over a period of time.
Let’s break it down.
A simple annual rate of return example could be as follows. Say you invested $1,000 into a mutual fund in January of last year, then by January of this year, you find yourself with $1,050. That’s after any fees have been paid from the fund to the company managing your funds. In this case, the annual rate of return, net of fees, is 5%. We got the number using the old percentage change formula you may (or may not) remember from high school math class: the new number, minus the old number, and the sum divided by the old number, or (1050-1000)/1000. There are other ways to calculate rates of return that include the timing of cash flows (the dollars in and the dollars out) but we will keep it simple for now.
It’s important to keep in mind that the annual rate of return changes from year to year. When the market is strong, you can see excellent rates of return (yay!). In more challenging times, though, like now with COVID-19, the economy and stock markets are impacted, and the rate of return could be low or even negative (boo). The good news is that for long-term investments, such as RESPs, one year with a not-so-great rate of return can be offset by the good years. Our most recent annual rate of return (from November 2018 to October 2019) was 10.4% (after fees). This rate of return also speaks to our expertise in providing our customers with a smart mix of assets.
Why investing early is key to growing your investments.
Now that we’ve covered the annual rate of return, let’s zoom out. Say you invest $2,500 a year in an RESP, beginning when your little one is looking up at the mobile above the crib, living in that special baby world of contrast and movement. How much will that RESP be worth by the time your drooly baby is 18? Let’s start with the contributions. If we multiply $2,500 by 18 years, we get $45,000. But wait, don’t forget about the Canada Education Savings Grant (CESG)! By contributing that magical $2,500 number, you will get the full CESG amount from the government—that’s an additional $500 a year, to a $7,200 total. So now, between yourself and the government, $52,200 will have been contributed to the RESP over the course of 18 years.
It’s time to add in the earnings. Say over time, your rate of return goes up and down, maybe 3% one year, 10% another, but on average, you get a 5% yearly return. This will mean that in 18 years… drum roll please… junior’s RESP could be worth a whopping $86,597*!
If you were home with the flu when they covered compounding in high school math class, you may be wondering how we got to that number. After all, $52,200 multiplied by 5% is only $2,610. But when you’re looking at growth over a decade or more, the formula isn’t so simple, because the earnings get compounded every 365 days. So, let’s break down this sample RESP’s growth:
- In the first year, you have $3,000 in contributions ($2,500 from you, $500 from the government), and you make, assuming a 5% annual rate of return, $150 in earnings. That means you’ll have $3,150 by year’s end.
- In the second year, you start off with $3,150 + this year’s contributions and grants of $3,000, totalling $6,150, which earns you $307.50 in earnings, again, assuming 5%.
- The following year, you’ll have $6,457.50 + the $3,000 contributions and grants, which will earn you $472.88
Notice a pattern here? The total amount you add to your RESP may be the same every year, but with compounding how much you earn increases each time that earth does a full turn around the sun. So while your annual rate of return might be 5%, over the course of 18 years, your actual rate of return could be more or it could be less too, but the goal is to build up contributions and earnings over time.
How CST Spark strives for great returns—even in light of market uncertainty.
At CST Spark, we rebalance your investment as your child ages with the goal of maximizing growth early and preserving your gains closer to graduation. We manage your investment mix according to your beneficiary’s age, and when they will likely attend post-secondary school. This is called age-based rebalancing, and its part of the disciplined approach we take to investing, which entails slowly and systematically rebalancing your investments and risk over time. So even when economies and markets ebb and flow, those CST Bright PlanTM beneficiaries with more years to go before post-secondary school have more time to benefit from the eventual market rebound. Specifically, when your child is a baby, we invest about 80% in equities (including Canadian, US, an international stocks), about 10% in global real estate, and another 10% in Canadian Fixed Income. We gradually change the weightings every year, until your child is 18 and more than 80% of the investment is in Canadian Fixed Income. You can see this in action on our handy (and fun!) asset mix pie. What we’re going for is high growth in the early years, and then safe and steady growth in the later years—to ensure those big early gains are protected to pay for post-secondary tuition and pizza for study sessions.
So what does this have to do with the rate of return? What it means is that your rate of return will be different depending on the age of your child.
Now, if you’ll let us brag for a minute.
At CST Spark, our most recent annual rate of return (from November 2018 to October 2019) was 10.4% (after fees). Of course, we can’t predict the future or guarantee a rate of return going forward. And remember that we’re investing for the long term with one goal in mind: that you can help pay for your child’s education, so some years will, no doubt, generate better returns than others. But that doesn’t take away from 10.4% being pretty good, and worth blowing our horn about—especially since it means we were able to make our customers’ money work harder for them! This rate of return also speaks to our expertise in setting up our customers with a strategic mix of assets. Needless to say, the fact that last year was a good one for the markets came into play too. Go markets!
You know how we keep talking about starting early with RESPs?
It’s largely so you can hit the ground running with your rate of return! Let’s talk more about that 10.4% rate of return. An RESP with Todd the toddler as the beneficiary may have scored from that impressive rate of return last year, while Tina the teenager’s RESP may have seen a lower rate of return. Here’s why: a toddler’s CST Bright Plan would be weighted towards stocks and stocks did really well last year. Meanwhile, a teenager’s CST Bright Plan would have seen a lower rate of return, because their investments would be more safely invested in fixed income—so that our customers can have the peace of mind knowing that they will be able to cover tuition and other post-secondary education-related bills if the market dips. In other words, we invest more heavily in equities in the early years with the goal of earning positive returns and then transition to more fixed income investments to preserve the income as your child gets closer to attending post-secondary.
All the more reason to start investing in a CST Bright PlanTM as early as possible!
Still have questions? We’re here for you. Drop us a line today and we’ll be happy to explain more about how RESPs work, as well as CST Spark’s investment strategy.
CST Bright PlanTM is sold by prospectus only.
*Future value of the RESP is based on contributions of $2,500 per year for 18 years and the applicable CESG. Earnings are based on a net annual average rate of return of 5% compounded annually.
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