Editor’s Note: A previous version of this article stated that, “Once the fiscal year is finished, however, you can never go back and compensate for previous years.”
It has since been changed to, “Once the fiscal year is finished, however, you can never go back and compensate for lost time, despite being able to roll missed contributions forward.”
In January, I showed how you can build a permanent TFSA income stream with Capital Power Corp (TSX: CPX). Holding dividend-payers like Capital Power in a tax-advantaged vehicle like a TFSA is one of the few “free lunches” in investing.
However, if you’re not careful, the benefits of a TFSA can be squandered. Every year, millions of Canadians fail to maximize the value of their TFSAs by making costly mistakes that could hurt them decades into the future.
Mistake #1: Avoiding dividend stocks
In general, dividend stocks seem to be overrated. In many cases, companies support their dividends through debt or share issuances. In that case, dividend payments are basically a wealth transfer from shareholders to themselves. Even worse, dividends are taxed, so investors could end up destroying their return on investment.
In a TFSA account, however, investments can grow tax-free. That way, you can reinvest each dividend to buy more shares without any tax consequences.
Take a stock like Bank of Nova Scotia (TSX: BNS)(NYSE: BNS), for example, which currently pays a 4.7% dividend. After taxes, that income stream could end up closer to 3%. In a TFSA account, you can receive the entire dividend, using it to accumulate more shares on a monthly or quarterly basis.
Mistake #2: Creating complexity
While TFSAs can help you avoid taxes, things can get complicated. Income from foreign securities or REITs can include a variety of things, from a return of capital to traditional capital gains.
While it’s not strictly necessary, ensuring that you only own Canadian securities can make the tax equation much easier.
Mistake #3: Not contributing enough
If you opened a TFSA, congratulations! The battle is only half over, though. The next step is to begin contributing.
Often, TFSA savers are happy that they are saving in the first place. This complacency can limit the urgency to up their savings rate.
The savings cap in 2019 for a TFSA is $6,000 per person. While it can be tough for everyone to max their contributions each year, this is a free lunch that doesn’t come twice. Once the fiscal year is finished, however, you can never go back and compensate for lost time, despite being able to roll missed contributions forward.
The biggest advantage any investor has is not skill, but time. Compound interest is rightfully called the eighth wonder of the world. If you’re not maxing out your TFSA contributions, see if there’s any more wiggle room in your budget to up your savings rate.
Mistake #4: Not contributing regularly
Markets go up, markets go down. It’s the way of the world.
Study after study has proven that timing the market is incredibly difficult. In most situations, it’s also a money-losing proposition.
Instead, your best strategy is to automate your savings. Investing a set amount of money each month not only makes it easier to invest, but also ensures that you’re putting capital to work whenever prices drop. Making automated, recurring investments each month is simply the greatest investing trick a saver can employ.
