As I am sure you’re aware, having a TFSA is one of the best ways to grow your money tax-free. The versatility of these accounts is especially noteworthy. As investors aren’t forced to limit themselves to a particular class of assets, it opens the door to a variety of possibilities.
However, while many shrewdly choose to hold stocks in their TFSAs, there is a danger to avoid something that’s at least as old as equity markets themselves: the failure to diversify. If you hold stocks — or are looking to add stocks — to your TFSA, here are two tips to help you diversify your stock picks.
Invest across sectors
It is obviously bad form to purchase shares of companies within a single industry. The probability that you incur serious losses as a result is higher. But going further, some industries have much lower correlations to the market than others.
Putting some of your money in quality stocks in such industries will probably not yield market-shattering returns, but it will provide some protection in times of economic downturns.
One such industry is the REITs industry. This industry has historically shown a low correlation with other asset classes, which helps with diversification purposes.
REITs are also required to distribute most of their earnings as dividends, and no one says no to some passive income.
One REIT to consider buying is Canadian Apartment Properties REIT (TSX:CAR.UN). This Toronto-based firm is one of Canada’s largest residential landlords. The company owns mostly residential properties near major urban centres.
The strategic location of Canadian Apartment’s residences allows the company to charge high premiums. The firm has delivered strong growth recently, with its share price increasing by more than 110% over the past five years.
This coincides with earnings growth of more than 200% over the same period. CAPREIT offers investors monthly dividend payouts and a dividend yield of 2.68% at writing. Finally, the firm’s beta of just 0.55 shows it is generally less risky than the market.
Practice a value investing approach
Value investors tend to gravitate toward stocks that are trading for less than their perceived intrinsic value. Of course, it isn’t easy to determine what exactly constitutes a company’s intrinsic value, but one good place to start is to look at a firm’s price-to-earnings ratio. Naturally, other factors matter just as much.
The company in question needs to possess strong fundamentals, a strong position within its industry, solid growth prospects, etc. When putting all these together, it is possible to find excellent stocks with the potential to help you grow your money tax-free for years.
One such stock to consider is Toronto-Dominion Bank (TSX:TD) (NYSE:TD). TD bank is one of the largest banks in Canada, both by market cap and in terms of assets owned. The firm not only possesses strong domestic operations, but also has solid footprints south of the border.
TD bank is perhaps the Canadian bank with the largest presence in the US. Overall, the Toronto-based financial institution displays strong fundamentals, but more relevant to our discussion,
TD bank is currently trading at just 11.69 times past and 9.92 times future earnings. The average S&P/TSX Composite Index price-to-earnings ratio is around 16. In short, TD bank is attractively valued at the moment.
The bottom line
While it is impossible to completely eliminate risk and volatility, you can decrease your exposure to risk by investing in stocks that have a low correlation with the market and by practicing a value investing approach.
Purchasing shares of TD bank and Canadian Apartment Properties could help you do just that.
Motley Fool Canada's market-beating team has just released a brand-new FREE report revealing 5 "dirt cheap" stocks that you can buy today for under $49 a share.
Our team thinks these 5 stocks are critically undervalued, but more importantly, could potentially make Canadian investors who act quickly a fortune.
Don't miss out! Simply click the link below to grab your free copy and discover all 5 of these stocks now.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Prosper Bakiny has no position in any of the stocks mentioned.