Canadians are increasingly relying on their own savings to provide ample income to fund a comfortable retirement.
This wasn’t always the case, but the employment world has changed in the past 20 years, and lifetime jobs with generous pension plans are quickly going the way of the dinosaur. Instead, contract work is more common. When a full-time gig finally does comes along, the benefits can vary significantly.
As a result, many Canadians are taking their retirement planning into their own hands, and for those at the beginning of their careers, the Tax-Free Savings Account (TFSA) is a useful tool.
The TFSA protects dividends from being taxed, giving investors an opportunity to invest the full value of the distributions in new shares. This sets off a powerful compounding process that can turn a modest initial investment into a nice nest egg over the course of two or three decades.
When the time comes to cash out and spend the savings, any capital gains are also tax-free.
Using the TFSA as the first option allows young investors to reserve RRSP room for later years, when they might be in a higher tax bracket and can benefit more fully from the contributions.
Which stocks should you buy?
The best names tend to have strong track records of dividend growth.
Let’s take a look at Toronto-Dominion Bank (TSX:TD)(NYSE:TD) and Fortis Inc. (TSX:FTS)(NYSE:FTS) to see why they might be interesting picks.
TD is primarily known for its Canadian operations, but the company has invested heavily in the United States over the past decade, and now has more branches south of the border than it does in the bank’s home country.
The U.S. businesses generate more than 30% of net income, providing investors with a nice hedge against any potential weakness in the Canadian economy.
The company has a compound annual dividend growth rate of about 10% over the past 20 years, and investors should see steady increases continue in line with earnings growth. TD’s distribution currently provides a yield of 3.3%.
A $10,000 investment in TD two decades ago would now be worth about $100,000 with the dividends reinvested.
Fortis owns natural gas distribution, power generation, and electric transmission assets in Canada, the United States, and the Caribbean.
The company has grown through strategic acquisitions over the years, with most of the recent investment activity in the United States, including last year’s US$11.3 billion purchase of Michigan-based ITC Holdings.
Fortis plans to raise the dividend by at least 6% per year through 2022. The company has increased the payout every year for more than four decades, so investors should feel comfortable with the guidance.
At the time of writing, the dividend provides a yield of 3.7%.
Long-term holders of this stock have also done well. A $10,000 investment in Fortis 20 years ago would be worth more than $90,000 today with the dividends reinvested.
The bottom line
While there’s no guarantee that these stocks will deliver the same returns in the future, the strategy of owning dividend growth stocks and investing the distributions in new shares is a proven one.
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Fool contributor Andrew Walker has no position in any stock mentioned.