How to Use a TFSA to Maximize Your Returns

Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) is an excellence investment for your TFSA. Here’s why.

| More on:

The Tax-Free Savings Account (TFSA) is a wonderful tool for investors of any age (specifically 18 or older with a valid social insurance number) to use to protect their investments against tax collection from the Canada Revenue Agency. If you have never contributed to a TFSA, you could have as much as $63,500 contribution room this year! Based on a 7% rate of return, your investment can double in a little over 10 years and triple in less than 17 years.

The compounding effect makes your investments grow faster the longer your money stays invested, which is why it takes less time to triple than double your investment. So, generally, you want to invest your savings as soon as possible. Here’s how you can maximize your returns with the help of your TFSA.

question mark

How to use a TFSA to maximize your returns

Many investors have fixed-income investments, such as bonds or GICs as a part of their diversified portfolio. These investments generate interests. As interests are taxed at a high tax rate, some investors automatically choose to hold bonds or GICs in tax-sheltered accounts such as TFSAs.

If you live in Ontario and you’re in the third tax bracket, earning $47,630-77,313 this year, the tax rates for the interests, capital gains, and eligible Canadian dividends you’ll earn can be as high as 29.65%, 14.83%, and 6.39%, respectively.

If you earn $2,500 of interests on the $63,500, you’d be paying $741.25 of taxes if the amount was invested outside of tax-sheltered accounts. On the other hand, if you book 7% of capital gains and receive 3% of dividends from investing in stocks with the $63,500, you’d be paying nearly $780.92 of taxes.

Ultimately, your decision on what to invest in your TFSA should depend on your investment strategy (e.g., allocation to bonds and stocks), followed by the amount of taxes you’ll save by investing in one type of investment over another. As illustrated above, from a purely returns perspective, there’s no reason not to own quality dividend stocks, which tend to outperform long-term bond returns in your TFSA.

A proven dividend stock that’s priced at a discount

Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) has been positioning itself for growth. It made a number of acquisitions last year, including in Canada, Colombia, and Chile, which could be slightly dilutive in the near term, but should lead to higher growth in the future.

Moreover, it continues to invest in technology, such as automation, machine learning, and artificial intelligence with the goal of reducing costs, enhancing productivity, and reducing error rates. The returns of technological investments are difficult to gauge, but nonetheless, the spending should help expand margins and grow earnings.

BNS Chart

BNS data by YCharts. Bank of Nova Scotia stock outperformed the market in total returns and income in the long run.

Currently, at $74 and change per share, Bank of Nova Scotia still trades at a decent discount of about 15% from its normal multiple. And over the next two years, it could appreciate as much as 28%. Irrespective of its valuation, combining the international bank’s stable earnings growth of about 6% and dividend yield of about 4.6%, the bank should still be able to deliver long-term returns of more than 10% from current levels.

Investor takeaway

First, decide on an investment strategy (e.g.,)  allocation to bonds and stocks) that works for you, and then estimate how much taxes you’ll save by investing each in your TFSA. Historically, quality dividend stocks have outperformed other investments over the long term. Therefore, investors should seriously consider buying stocks like Bank of Nova Scotia, especially on dips, for their TFSAs. This will lead to decades of tax-free returns and dividend income!

Fool contributor Kay Ng owns shares of The Bank of Nova Scotia. Bank of Nova Scotia is a recommendation of Stock Advisor Canada.

More on Dividend Stocks

Close-up of people hands taking slices of pepperoni pizza from wooden board.
Dividend Stocks

How to Generate $150 in Passive Income With $30,000 in 3 Stocks

These three high-yield TSX dividend stocks can significantly enhance your monthly passive income.

Read more »

Investor reading the newspaper
Dividend Stocks

2 Canadian Stocks That Just Raised Their Payouts Again

Looking for a great combination of income and capital growth. These two stocks have decades-long histories of increasing their dividend…

Read more »

dividend stocks are a good way to earn passive income
Dividend Stocks

Looking for a 5.4% Average Yield? These 3 TSX Stocks Are Worth a Look

Considering their excellent track record of dividend paying, solid underlying businesses, and healthy outlook, these three TSX stocks are ideal…

Read more »

telehealth stocks
Dividend Stocks

This TSX Stock Pays a 4.3% Dividend Every Single Month

This TSX stock pays you cash every single month – and it’s backed by a growing, essential business.

Read more »

3 colorful arrows racing straight up on a black background.
Dividend Stocks

2 Great Warren Buffett Stocks to Buy Before They Raise Their Dividends Again

If you want to invest like Warren Buffett, these two top Canadian dividend stocks are some of the best picks…

Read more »

Map of Canada with city lights illuminated
Dividend Stocks

A Dirt-Cheap Canadian Dividend Growth Stock Built for the Long Haul

A dirt‑cheap Canadian dividend growth stock offering stability, steady income, and reliable annual payout increases for long‑term investors.

Read more »

middle-aged couple work together on laptop
Dividend Stocks

Turn Dividends Into Paydays: 2 Top TSX Stocks for Reliable Monthly Income

Exchange Income Corp. (TSX:EIF) and another monthly payer worth buying up on strength.

Read more »

pig shows concept of sustainable investing
Dividend Stocks

TFSA Investors: 1 Perfect Monthly Dividend Stock With a 7.7% Yield

This grocery-anchored REIT aims to deliver reliable monthly TFSA income, but its payout coverage is the key metric to watch.

Read more »