I’m convinced a million bucks is enough for most middle-class folks to retire.
Financial advisors and others in the business of accumulating assets under management think differently, of course. They like to scare people into thinking they need several million to avoid eating cat food during their golden years.
Nothing could be further from the truth. Most Canadians should be able to count on Canada Pension Plan payments, and Old Age Security kicks in for seniors who are truly destitute. Add in dividends from a reasonably sized retirement account, and most Canadians will be just fine.
Besides, expenses go down considerably in retirement. Work clothes are no longer a necessity; neither is a commute. Retirees no longer need to save, either. And dividend income is taxed at a much lower rate.
In short, all you need to worry about is getting to $1 million and paying off your house. Here’s how you can get to a million dollars simply by saving and investing inside your TFSA.
The power of tax-free compounding
I’m constantly amazed when I meet investors who haven’t maxed out their TFSA.
There’s one powerful difference between TFSAs and RRSPs. While both allow investments to compound tax free, RRSPs come with a tax liability at the end of their lives. Any withdrawals are taxed as ordinary income. TFSAs, meanwhile, can be cashed out without incurring a tax liability.
Say you have $20,000 in your TFSA today and will contribute the maximum — currently set at $5,500 annually — for the next 40 years. At an 8% return, the investment will be worth nearly $2 million — $1.97 million to be exact.
If that $1.97 million spins off a 4% yield, it would generate passive, tax-free income of $78,800 per year. Not bad!
There’s just one factor we must consider, however, and that’s inflation. If inflation averages 2% per year in the next 40 years, it’ll cut purchasing power approximately in half, meaning a $1.97 million nest egg will be worth about $1 million in today’s dollars. It’ll still be enough for a comfortable retirement.
How to get there
Now that we’ve established it’s possible to secure a great retirement using just a TFSA, it’s time to look at how you can get there. The easiest way is to buy great stocks today and hold them for a very long time.
Take Methanex Corporation (TSX:MX)(NASDAQ:MEOH), a stock that hardly gets talked about. The company is the world’s leading producer of methanol, which is used as an essential ingredient to produce hundreds of common industrial and consumer items. It’s also a fuel used primarily by ocean shippers.
Methanol is a good business, and Methanex has done a fantastic job of rewarding shareholders. It has repurchased more than 50% of its outstanding shares in the last 20 years as well as raised its quarterly dividend 11 times since first establishing it in 2002. Shares currently yield 2.8%.
In the last 15 years, including reinvested dividends, Methanex shares have gained 14.3% a year — enough to turn a $10,000 original investment into something worth $74,056.
Another great long-term stock has been Linamar Corporation (TSX:LNR), which has quietly become one of the world’s top auto parts manufacturers. It employs 24,500 employees across 17 countries.
Linamar shares are incredibly cheap on a price-to-earnings basis because investors just aren’t excited about the auto industry. They currently trade hands at just 7.4 times trailing earnings.
Like Methanex, Linamar shares have been a terrific long-term hold. Including reinvested dividends, shares are up 13% annually since 2002, turning a $10,000 initial investment in May 2002 into one worth $62,749 today.
The bottom line
Both Methanex and Linamar are hardly household names. But if you combine these kinds of companies with the tax-free compounding power of a TFSA, good things are bound to happen. It might even be enough to fund your entire retirement.
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Fool contributor Nelson Smith has no position in any stocks mentioned.