It’s easy to learn about and avoid certain technical mistakes when investing in your Tax-Free Savings Account (TFSA). For example, most TFSA holders understand the contribution limits and possible consequences of overcontributing.
However, some technicalities fall in the grey area, and it’s relatively easy to make a mistake with them. Similarly, you can inadvertently commit some massive mistakes with your TFSA while remaining well within the utilization scope and without incurring any penalty.
Mistake # 1: Unhealthy trading frequency
This is one of the “grey area” mistakes easy to make with a TFSA. There is no well-defined distinction between investing and trading in your TFSA while one is allowed and one isn’t. You can use your TFSA to grow your wealth through long-term investments, but if the CRA determines that you are using your TFSA for trading, it will lose its tax-free status, and your income will be taxed as business income.
So, to stay safe, try to stick with stocks you can hold for years or decades, as much as possible. However, that doesn’t mean you only have to pick stocks you can hold forever. For example, if you had invested in Athabasca Oil (TSX:ATH) at the end of 2020 when it was clear that the energy sector was going bullish, you would have grown your capital by 1,700% by now.
The energy sector is still going strong but considering the strength of the bullish momentum and uncertain market conditions involving multiple variables, including geopolitical problems, indicate that a correction is due.
Even if it’s as near as the end of the current year, and you sell right around the time the stock starts slumping for good, you would have still owned the stock for nearly two years. This is enough time for a stock to be considered a long-term holding.
Mistake # 2: Only using TFSA for short-term financial goals
The TFSA is an all-purpose tool, unlike an RRSP, created primarily for retirement savings. Therefore, many Canadians decide to use the RRSP strictly for that purpose and the TFSA for other investment goals, like growing their savings for a new house or a better car. However, that’s not what the TFSA should be limited to.
It can be a powerful account for retirement savings. The more money you have in your TFSA, the more you can add to your retirement income without pushing your tax bill beyond proportions.
You can look for a long-term holding like Ecosynthetix (TSX:ECO), a sustainable renewable chemicals company. It creates biomaterials that are eco-friendly replacements for many of the mainstream and potentially harmful substances used in various industries. Currently, it caters mostly to the construction industry and paper and paperboard industry.
The stock’s performance has been cyclical almost since inception. And if you buy it low, you may be able to double your money in under five years if it keeps performing the way it has in the past.
It’s easy to make these kinds of mistakes with your TFSA when you are not being careful and considerate about its limitations and potential. Understanding what you can do with your TFSA won’t just help you avoid such mistakes; it will also allow you to optimally utilize it for your short-term and long-term wealth-building goals.