In the good ol’ days, planning for retirement was pretty much taken care of through generous defined-benefit pension plans, but times have changed.
What’s going on?
Full-time employment with any benefits at all is becoming scarce, and the pension plans that are provided are more likely to be defined-contribution, rather than defined-benefit.
In addition, boomers and their parents have watched the value of their homes climb significantly, ensuring a nice back-up plan in the event they didn’t have a pension through their work.
Today’s young home buyers are faced with an overpriced market that is making it nearly impossible to purchase in some cities. And if young couples do manage to buy, there is a chance the home might not be worth more 25 years from now.
At the very least, the gains probably won’t be comparable to those enjoyed by their parents and grandparents.
So, what should young investors do?
The power of compounding
One option is to buy dividend-growth stocks inside a TFSA and invest the dividends in new shares. This sets off a powerful compounding process that can turn a modest initial investment into a serious pile of savings over time.
Which stocks should you buy?
The best companies have strong track records of dividend growth supported by rising earnings. Ideally, they also hold leadership positions in industries with relatively high barriers to entry.
Canada has a number of such examples, but one that stands out is Canadian National Railway Company (TSX:CNR)(NYSE:CNI).
CN is the only railway in North America that can offer its customers access to three coasts. The odds of new tracks being constructed on major routes are pretty slim, and railway mergers tend to run into regulatory roadblocks, so CN’s position should be quite secure.
The company still has to compete with trucks and other railways on some routes, so management works hard at making sure the business runs as efficiently as possible. In fact, CN is widely viewed as the best-run company in the industry.
CN is very profitable, even when the economy hits a rough patch. The business generates significant free cash flow and investors get a nice chunk of it through share buybacks and dividend increases.
A quick look at the 1.7% yield might turn some investors off, but CN has a dividend-growth rate that has averaged better than 16% per year over the past decade.
Returns?
A $10,000 investment in CN just 20 years ago would be worth $390,000 today with the dividends reinvested.
The bottom line
There is no guarantee that CN will generate the same returns over the next two decades, but the strategy of buying top dividend-growth stocks and reinvesting the dividends in new shares is a proven one.
With a bit of discipline and patience, young investors can take advantage of the power of compounding inside their TFSA to build a significant tax-free retirement portfolio.
