The holidays are full of surprises, and once in a while people come across a financial windfall.
The cash might be from a gift, a lottery ticket, an inheritance, or the sale of an old painting you found in the attic that is now worth some decent money.
Regardless of the source, one wise use of the funds would be to invest inside a Tax-Free Savings Account (TFSA). The contribution limit for the TFSA in 2020 will increase by $6,000 per person, bringing the cumulative space since inception to $69,500. That means a couple would have as much as $139,000 in TFSA contribution room beginning in 2020.
Any income generated inside the TFSA isn’t taxed, which means the full value of interest or dividend payments can be reinvested to start compounding returns.
In the case of dividend stocks, which generally provide higher yield than fixed-income alternatives, the investment of the payouts into new shares can normally be set up to occur automatically, which means you don’t have to monitor the fund all the time.
When the compounding process has a couple of decades to work its magic, investors who start out with a relatively modest sum can find themselves sitting on a large nest egg.
The secret lies in buying top-quality stocks that pay rising dividends each year and boost the return through growth in the share price.
Let’s take a look at Canadian National Railway Company (TSX: CNR)(NYSE: CNI) to see why it has delivered solid returns and should continue to be an attractive pick.
Essential service
CN transports lumber, coal, crude oil, cars, grain, fertilizers, sand, manufacturing components, chemicals and finished goods across Canada and through the heart of the United States.
In total, the company moves $250 billion in goods each year along nearly 20,000 route miles of tracks with connections to three coasts. In a nutshell, CN is the backbone of the Canadian and U.S. economies.
The company is very profitable and has adequate cash to invest in new infrastructure. In 2019, CN spent nearly $4 billion on network upgrades, new locomotives and additional rail cars.
In the first nine months, CN generated $1.5 billion in free cash flow that is available to pay dividends and buy back shares. This is important because top companies fund dividend increases from free cash flow growth, rather than through share issues or taking on new debt.
CN raised the dividend by 18% in 2019 and another healthy increase should be on the way next year. The board has bumped up the payout by a compound annual rate of roughly 16% over the past 20 years.
Returns?
An investor who purchased $10,000 worth of CN stock 20 years ago would have $230,000 today with the dividends reinvested. A $100,000 investment would be worth $2.3 million!
The bottom line
CN might not deliver the same results over the next two decades but the stock deserves to be part of a TFSA pension portfolio.
The strategy of buying quality dividend stocks and investing the distributions in new shares is time tested, and the TSX Index is home to many top stocks that have made long-term investors rich.
