Investment is a great way to build wealth faster. It is also a fantastic tool to create a passive-income stream. How you make money from an investment can be different. The two most common ways are selling stocks and receiving dividend payouts.
Whatever your investment strategy is, the TFSA is a great tool for investing. You don’t need to pay any taxes on your TFSA money. Whether it’s the money you withdraw, dividends you receive, or any profit you make by selling stocks, every penny is yours to keep (unless you overcontribute).
If you opt for the tried-and-tested method of generating a passive income through dividends using TFSA, it will go something like this. The current contribution limit, if you haven’t used a TFSA up till now and have been an adult since or before 2009, is $63,500. If you start by maxing out your contribution now and keep adding $6,000 a year, you will have contributed $100,000 in fewer than seven years.
Let’s assume you have grown this number via compounding and buying some profitable stocks. You might be sitting on a nest egg of $250,000 after seven years. With this sum, you can easily create a $1,000 a month passive revenue stream, if you buy in a company with a dividend yield of 5%.
But that’s not the only way to do it.
Buying a growth stock
A stock that increases your capital gains at a rate faster than the industry average can get you to $1,000 a month much quicker. Growth stocks like these usually don’t pay any dividends, and you will have to generate income by occasionally selling the shares and earning a tidy profit.
Consider a stock like Shopify, for example. Shopify has grown about 120% just this year. This pace is in accordance with the last five years’ growth of almost 600%. Even if market value growth pace comes down to 100% a year, your initial sum of $63,500 will reach the quarter-million mark in just four years. Then you can find a dividend stock with a 5% yield and enjoy $1,000 a month.
Reinvesting dividends
A very different approach would to buy a dividend stock and start reinvesting your profits instead of cashing them out. Even at its best pace, it’s a slow approach; especially if the company’s market value is stagnant, and you are not growing your capital gains.
Let’s say you invest in the TSX leader and the largest bank in the country, Royal Bank of Canada. It also happens to be a dividend royalty, with a history of increasing dividends for eight consecutive years. Right now, the dividend yield is 3.86%. For the sake of simple calculation, let’s consider it at 4%.
Now, if you want to grow your sum to $250,000, with just accumulating dividends and contributing $6,000 a year besides, it will take a very long time. About 22 years to be exact. But, if you start reinvesting your dividends, which means buying stocks in the same company with the dividend amount instead of taking the payout, you can cut that time a lot shorter.
Foolish takeaway
The discrepancies between these two methods make one seem much more rewarding than the other. But you have to understand that faster growth comes at a higher risk. Besides, if you consider the capital gain of your dividend stocks, along with the dividend re-investment, you can reach your mark a lot quicker.
