At the beginning of January, I set the following goal for the financial well being of our baby daughter. I am happy to report that I have started putting this plan into motion.
> New portfolio for our daughter – In 2016, my wife and I welcomed our daughter. Time to set things in motion for the financial well being of our baby daughter.
- We have opened up a new RESP (Registered Education Savings Plan) account, which allows us to save and invest for her post-secondary education. The plan allows us to get education grant money from the government and is tax-deferred on the income generated. We intend to start investing this money soon and will post an update on which stocks/ETFs we chose.
- In addition to the RESP plan, we intend to start a DRIP plan to put away a small amount of money each month (starting off with $100/month for now) that will be her nest egg when she is an adult. Time is one of the most powerful weapons in an investor’s arsenal and starting off a DRIP plan allows us to let the investment compound over the course of 20-ish years. I’ll post an update soon on which stock I am picking for this plan.
The Education Plan
A quick background on the Registered Education Savings Plan (RESP). RESP is an account type available to Canadians to save, invest and grow funds for post-secondary education. While not only limited to kids, it is generally targeted to help parents save for their kids’ education. The best part of this plan is that the government matches the contributions via the Canada Education Savings Grant (CESG). The grant amount is 20% of contributions to a max of $500 per year. So, to maximize the benefits, we would contribute $2,500 per year into this account.
The money in this account is tax sheltered. My contributions are after-tax dollars, so withdrawing that amount from the account when Baby R2R goes to college/university does not incur any tax implications. But the rest of the money is taxed (all the accumulated dividends, capital gains, CESG grant amounts etc), but taxed at our daughter’s income tax rate, which will be lower when she’s in school.
For this account, I have chosen to go with index funds rather than individual stocks/bonds. I am following a similar model that I chose for my wife’s portfolio. I am going to take a 60/40 approach, but in the future may turn the dials up and down a bit, but not far off this balance.
I will use 4 funds for this portfolio as summarized below.
|Exposure||Fund Name||Ticker||MER||# of holdings||Yield||Target Allocation|
|Canadian Equity||BMO S&P/TSX Capped Composite Index ETF||ZCN.TO||0.06%||250||2.7%||20%|
|International Equity||Vanguard FTSE All World Ex-Canada Index ETF||VXC.TO||0.27%||9,782||1.86%||40%|
|Canadian Fixed Income||BMO Aggregate Bond Index ETF||ZAG.TO||0.09%||10*||3.08%||20%|
|Emerging Market Fixed Income||BMO EM Bond CAD-Hedged ETF||ZEF.TO||0.56%||57||4.67%||20%|
*ZAG holds 10 other bond ETFs
As noted in the table, the diversification of the four funds to follow the 60/40 approach will follow: 20% in Canadian Index (ZCN.TO), 40% in All World Ex-Canada Index (VXC.TO), 20% in Canadian bonds (ZAG.TO), and 20% in EM bonds (ZEF.TO). Based on the ETF composition, the breakdown is:
The above portfolio results in a weighted average MER of 0.25% and a weighted average yield of 2.83%.
The Nest Egg
As for the second part of the goal, I wanted to originally start a DRIP plan and put away a small amount of money each month, so that our daughter would have a decent sized nest egg when she’s an adult. At $100/month, in 20 years that would amount to $24,000 just in contribution amount.
My original thought process had been to contribute monthly in a non-registered DRIP account and simply swallow the tax imposed (even when a stock is held in-trust for my daughter, the income is taxed based at my tax rate). Even though dividends from Canadian companies (eligible dividends) get a favorable tax rate, this creates a drag on the overall returns over the next two decades.
To avoid this drag, I decided to invest on her behalf in my tax sheltered account — the Tax Free Savings Account (TFSA). The account allows me to invest and grow my money completely tax free (for both capital gains and dividends). I will simply earmark a portion of my account to belong to my daughter and will pass it on to her when the time comes.
The biggest advantage of DRIP plans is the dollar cost averaging that investors can achieve without transaction costs. While transaction costs are low in my brokerage account ($5 per trade), it is still a cost. To avoid spending $5 each month, I have decided to simply make 1 or 2 trades per year and forgo the more granular monthly dollar cost averaging. The other disadvantage is that I dont get a full-DRIP and only synthetic DRIP with this type of investment setup. But overall, I think the advantage of tax shelter trumps (poor choice of word these days) the disadvantages.
Now, to the more interesting part — which stock to choose. I have decided to go with one of the oldest and the first dividend paying company in Canadian corporate history: Bank of Montreal (BMO)
BMO needs no introduction…the bank was founded in 1817 (celebrated its 200 year history a couple of weeks ago) and started issuing dividends in 1829. In fact, BMO has issued dividends consecutively ever since and has only reduced dividends once (in 1942). That kind of a history gives me tremendous confidence that the company will continue to flourish and pay dividends quarter after quarter for decades to come.
Last month, I bought 12 shares of Bank of Montreal (BMO.TO) @ C$99.43. The stock yields $3.52 annually contributing $42.24 towards my daughter’s annual income (her first income 🙂 )