The Tax-Free Savings Account (TFSA) is a tool that can be used to create long-term wealth. But only a fraction of Canadian residents realize the potential of this registered account.
In fact, several Canadians think the TFSA is just a savings account. But you can hold several qualified investments in the TFSA that include stocks, mutual funds, bonds, and exchange-traded funds, or ETFs.
The TFSA also offers you a ton of flexibility as you can withdraw or liquidate your holdings at any time without paying taxes to the Canada Revenue Agency. So, you can hold short-term bonds in the TFSA and create an emergency fund, while long-term investors can use the registered account to hold a portfolio of quality stocks.
The TFSA was launched in 2009, and the cumulative contribution room available in 2023 has risen to $88,000. So, if you have $88,000 to invest in a TFSA, here’s how you can build it to $1 million.
Benefit from the power of compounding
Albert Einstein once claimed the power of compounding is the eighth wonder of the world. It’s crucial to begin your investment journey as early as possible and put your cash to work.
For example, if you invest $1,500 each month for a period of 35 years, your portfolio will be worth close to $1 million, given annual returns of 12%. However, if you delay these investments by 10 years, you will have to invest over $5,000 each month.
Maximize TFSA contributions each year
You need to calculate your TFSA contributions each year as the number is indexed to inflation. In 2023, the TFSA contribution room has increased to $6,500 from $6,000 in 2022. It’s important to maximize your TFSA contributions every year, as any unused contribution room can be carried forward to subsequent years.
In the last 14 years, the S&P 500 index has returned 14% annually to investors after adjusting for dividends. So, if you invested $500 each month in the S&P 500 in the last 14 years, your TFSA portfolio would be worth around $250,000 today.
If you stop investing, this amount will still surge to $1 million in the next 14 years in case the S&P 500 rises 10% each year.
Identify winning bets
In addition to regular and long-term contributions, you also need to choose asset classes that have the potential to deliver outsized gains over time. So, create a diversified portfolio of growth, dividend, and blue-chip stocks in the TFSA to help you achieve financial targets faster.
What to hold in a TFSA
As stated earlier, your portfolio should be well diversified with a mix of bonds, stocks, and ETFs. If you are younger, you can have greater exposure to riskier assets such as growth stocks. But if you are close to retirement, it makes sense to invest in bonds and ETFs.
So, a 25-year-old investor can hold 20% of total holdings in bonds and 50% in index funds such as the S&P 500. The rest can be allocated toward quality growth stocks such as Apple (NASDAQ:AAPL), Amazon, Shopify, Nvidia, and Docebo.
An investment of $10,000 each in Amazon and Apple 10 years back would be worth $319,000 and $443,000, respectively, today.
While investing in growth stocks, you need to identify companies that enjoy a wide economic moat and are part of an expanding addressable market. The fundamentals of these companies should be sound, allowing them to thrive across market cycles.
For example, Apple has a diversified revenue base and continues to expand its portfolio of products and services. It has consistently delivered market-beating gains to shareholders, easily outpacing most broader indices.
For those with a higher risk appetite, investing in spot-Bitcoin ETFs may also be a good strategy if you are bullish on the widespread adoption of cryptocurrencies in the upcoming decade.
Your investment strategy will basically depend on your age, financial goals, available capital, and risk-tolerance levels.
