The power of long-term tax-free compounding is both profoundly powerful and difficult to fathom for many new investors who’ve yet to crunch the numbers.
In a prior piece, we did the math and showed that simply contributing the maximum annual contribution to a TFSA while using the proceeds to invest in a basket of blue-chip stocks, REITs, and other high-quality investments allowed a young investor to grow their wealth to unbelievable heights over time.
Assuming a 9% annual return from an instrument like BMO Low Volatility Canadian Equity ETF (TSX:ZLB) on $57,500 in TFSA principal and $5,500 in annual contributions per year (the maximum annual TFSA contribution has since jumped to $6,000), I did the time-value-of-money problem and showed that over “10, 20, 30, and 40 years, your TFSA would have swollen to around $220,000, $604,000, $1,500,000, and $3,700,000, respectively.”
To many beginners, turning $57,500 into $3.7 million is like turning water into wine!
It seems far-fetched, but it really isn’t. These are kinds of rewards that’ll await you in a few decades if you just stick with a simple TFSA investment plan and keep topping it up every single year. And best of all, you don’t need to line the pockets of a “professional” money manager to grow your wealth substantially over time.
Moreover, you could accelerate the rate of growth in your TFSA beyond 9% if you’re willing to go the extra mile with your research.
By hanging on to higher-growth small- or mid-cap names, investing in high-quality stocks within booming emerging markets, not attempting to time your entries and exits from the markets, or by taking the contrarian role of being a buyer during steep market downturns, you can vastly improve your chances of beating the market and scoring a high double-digit return on your investments.
So, the numbers I just showed you in the second paragraph of this piece aren’t even assuming the best-case scenario. It’s a realistic scenario that factors in corrections, recessions, and the indigestion that usually comes with investing in the market.
If you don’t have the time or stomach to go on the hunt for securities that’ll better enable you to get the highest annualized return over time, you can keep adding to ZLB, a wonderful smart-beta basket of stocks that’ll have your back in a bear market. Prudent investors should have a look at the constituents, and they’ll quickly find that there’s a theme that extends beyond just low-beta metrics. Each constituent is a free-cash-flow-generative firm that has a proven track record of delivering above-average returns relative to the risks taken on over prolonged periods of time.
You get a good blend of stocks within conservative sectors (REITs, utilities, and telecoms). You’re also gaining immediate access to overlooked financials, and various other “boring” securities that zig when the markets zag. As a result, ZLB is within 1% of its all-time high at a time when the tech-heavy NASDAQ is flirting with correction territory.
There are a multitude of ways to get rich over time. You can chase the “sexy” growth play and endure a rocky road to a slightly bigger retirement nest egg, you can smooth the ride with ZLB, or you can do mix both and find the perfect blend that suits your investment profile.
In any case, it’s essential that you don’t trade in and out of the market based on where the talking heads on TV think the markets are headed next. While you’ll eliminate your downside risk, you’ll also be risking your upside. And if you’ve got decades to invest, I’d argue taking on upside risk (the risk of missing upside) is far greater if you’re a new investor who isn’t well versed in swing trading.
Stay hungry. Stay Foolish.
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Fool contributor Joey Frenette owns shares of BMO Low Volatility CAD Equity ETF.