Thursday, 28 May 2009

Investing for Children: RESP or In-Trust For Account?

Suppose parents or grandparents want to set aside money for a child. Or suppose a minor child (under age 18 or 19 depending on the province) receives a significant inheritance, or has part-time or summer job earnings that you think should be put away to grow, perhaps for higher education or an eventual house purchase.

The money will be safe in a bank account but not earning much. GICs are also safe but grow slowly. If the intended spending is many years away, investing is an attractive option but there is a problem - legal restrictions prevent minors from opening an investment account in their own name.

Two options may provide a solution. Both are typically available at discount brokerages. The new TFSA is not an option since only those 18 and over can have one in their name.

Registered Education Savings Plan (RESP)
This is a special plan created by the Government of Canada to assist savings for post-secondary education by allowing tax-free growth inside the plan and by providing extra grants, the Canada Education Savings Grant (CESG) for everyone and the Canada Learning Bond for lower income families (details at

Informal Trust aka In-Trust For - (ITF) Account
In such an account, a parent or other adult acts as trustee to manage investments on behalf of the child, who becomes legally entitled to take over at the age of majority. In this type of account, there is no restriction for how or when the funds may be withdrawn and spent (Invesco Trimark describes the basics here).

There are many important differences between RESPs and ITFs in terms of control, ownership, flexibility, grant availability and especially taxation, some of the key ones of which are summarized in the chart below. RESPs and ITFs are essentially equal when it comes to investing itself as all types of stocks and bonds are allowed in both and in allowing virtually anyone to contribute.

Assuming that the possibility of further education is a goal and other things being equal, my take on how RESPs and ITFs shake out are this:
  • it is worth contributing enough to the RESP to get the full government grant money, which means making contributions over a period of years, instead of all at once
  • if there is enough money, put the max CESG amount in the RESP and the rest in an ITF
  • to keep things simple, parent or grand-parent money should go into the RESP before it goes into the ITF
  • put the child's own money into an ITF; in this case, the tax attribution complexity doesn't arise; there will be no taxes for the child to pay unless the sum to invest is very large and produces more than the basic personal tax-free allowance in income every year (e.g. in 2009 the personal allowance is $10,320, which is equivalent to 6% on $172,000)
Of course, things are never exactly equal or the same for every person, so it behooves readers to think carefully about the various factors before deciding what to do. Form-filling and trustee arrangements (separate persons to be trustee and contributor) in compliance with laws and regulations, especially with regard to the ITF option, is critical if the tax benefits are not to be denied by the Canada Revenue Agency. This blog post is not advice. It may well be worth getting proper accounting or legal advice.

More Background:

Tuesday, 26 May 2009

How Long Till the Stock Market Recovers?

From time immemorial astrologers have been foretelling the future. They are still at it. Back in January, Vedic Astrologer said the stock market will be good in March (correct), bad in April (wrong), good in May (correct) and June but "A New Moon Solar Eclipse in July 2009 will not be good for Stock Market; there may be some crisis in Stock Market."

Those with a more rationalist bent may discount such prognostications but the question of how long it will take before the stock market regains former highs or even begins rising is an important and valid issue. Various methods propose an answer.

The History of Past Downturns and Recoveries
There have been dramatic stock market downturns associated with severe economic slumps similar to the current episode in the past. The most extreme example is the the 1929 crash and depression that followed. Crestmont Research's Stock Matrix Options chart shows that a taxable US investor who had invested at the peak in 1929 would have had to wait 22 years to break even after inflation with an investment in the S&P 500. Will it be as bad this time?

Fund provider IFA's Probability of Portfolio Recovery page graphs in figure 9-B the chances that portfolios with various mixes of stocks and bonds will recover within a certain number of years. The graph says two significant things:
  • full recovery will probably take a long time - e.g. a portfolio of 50% stocks and 50% bonds is 90% sure to fully recover in 14 years, though there is a 50% chance it could be only 7 years
  • portfolios with a lower proportion of stocks will likely recover more quickly than one with just stocks since they will not have fallen so much in the first place
Secular Market Cycles
This approach maintains that stocks markets go through long term cycles in which stock prices rise unduly compared to earnings and thus the Price to Earnings Ratio (P/E) goes above the normal long term average of about 15x. John Mauldin in While Rome Burns graphs the excessive rise in P/E in recent years and shows that in past cycles, the inevitable correction drove prices and the P/E down below the average. The suggestion is that the correct market downturn may not be over yet and a new bull market probably won't start till the middle of the next decade, after which returns climb strongly again.

Robert Schiller, the author of investing book Irrational Exuberance, expounds a similar view in this Yahoo Finance article and video clip, saying that the S&P 500 P/E is likely to go down to 10x from its current 14x before climbing again.

Credit Crises, Real Estate Slumps and Market Crashes
A third method of trying to figure out when bad times might end and good times return comes from economic studies. International Monetary Fund researchers posted Global Financial Crisis: How Long? How Deep? over at Vox EU in which they summarized past episodes of such crises - yes, they have happened before, though not on a global scale - and found that recessions could last up to four years with stock market declines of up to 50%.

Lessons for an Investor:
  • stock / equity investing is for the long term, at least ten years, better 15 years;
  • reasonable expectations will increase patience in the downturn, avoiding the error of selling after the downturn; cautious expectations will also improve investment planning
  • a portfolio approach is the way to go: mixed portfolios of stocks and bonds cope better with market cycles
  • portfolio composition needs to be aligned with investment objective time frames
  • markets do recover, even extreme downturns are eventually followed by upward cycles