Hate Taxes? Then Don’t Make This Common TFSA Mistake!

Why Fortis Inc. (TSX:FTS)(NYSE:FTS) is the ultimate holding for Canadians instead of this common, return-crippling TFSA mistake.

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Your Tax-Free Savings Account (TFSA) is an invaluable tool that you can use to reduce your tax bill substantially.

Shockingly, many Canadians aren’t using it to its full potential, with sub-par investments like GICs, bonds, and cash taking up a majority of the space that could have been used for stocks and REITs, which could deliver massive tax-free capital gains over time.

A common mistake among TFSA users is using the TFSA for overly conservative investments like bonds, and using non-registered accounts for “risky” stocks. While it is true that realized losses in a TFSA can’t be used to offset capital gains in other accounts, it’s also true that capital gains and dividends held outside a TFSA are subject to taxation, which could lead to a hefty bill at the end of the year, depending on your income bracket.

So, unless you’ve got plenty of losers to offset your winners, it makes more sense to hold investments like stocks in your TFSA, especially since you should be making a long-term commitment to stay in the markets for years, if not decades at a time.

You may have already noticed that by playing it too safe with your TFSA, you’ve ended up paying hundreds if not thousands in extra taxes that could have been legally avoided through a less conservative TFSA allocation. Growth stocks, Canadian dividend stocks, and non-dividend-paying U.S. stocks ought to be considered for your TFSA.

Conservative securities, cash, and cash equivalents ought to be left out of your TFSA because the return you’ll get from savings and interest is really not worth shielding from tax compared to the significant gains you’ll stand to have with stocks.

That said, it’s not a good idea to do too much trading on sexy plays like pot stocks with your TFSA. A TFSA dollar is a worth a heck of a lot more than a non-TFSA dollar through the power of long-term tax-free compounding. So, it is worthwhile to not waste such a precious resource on an investment you don’t see yourself holding for many years.

Some risk aversion is warranted, but for those looking to reduce their TFSA cash hoard for some safe and sound securities, there are bond proxies like Fortis (TSX:FTS)(NYSE:FTS), which will allow investors stable returns, dividend growth, and an upfront yield that blows “risk-free” fixed-income securities out of the water.

Fortis is a regulated utility with rock-solid cash flows and an above-average growth profile, thanks to its impressive U.S. presence. Management keeps finding ways to grow its dividend by 5% to 6% per year, and with shares exhibiting minimal volatility relative to the broader markets, it’s not a mystery why the stock is so popular among Canadian retirees.

The best part of Fortis isn’t its growth profile or its dividend growth, though. It’s the peace of mind that it can offer new investors who may be reluctant to overexpose their TFSAs to so-called risky assets like stocks. The 2007–08 financial crisis was a relatively small ~25% bump in the road for Fortis, and wasn’t too big a deal for its investors, as the company continued rolling along as if there were no crisis happening.

With all the talk of a recession, it may seem like a good idea to continue hoarding cash and bonds in a TFSA, but doing so is timing the market and likely won’t deliver strong results for beginner investors over time.

Foolish takeaway

If you hate paying taxes on capital gains, you’re going to want to avoid hoarding cash in those “high interest” TFSA savings accounts and start using it for more rewarding securities. It’s always a good idea to have dry powder on the sidelines, but for Canadians, those sidelines should be in a non-registered account, and not a TFSA.

Stay hungry. Stay Foolish.

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 Joey Frenette owns shares of FORTIS INC.

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