This Is the Only Mistake You Need to Avoid in Your TFSA

TFSA investors should avoid taking excessive risk and instead focus on holding quality dividend stocks in their equity portfolios.

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Most Canadians know that any income earned in a TFSA (Tax-Free Savings Account) is exempt from taxes. Due to its tax-sheltered status, investors might want to take excessive risk to generate outsized gains and buy fundamentally weak penny stocks in the process.

However, it’s crucial to understand that investing is a marathon and not a sprint. You need to take a long-term approach to invest in equities and benefit from the power of compounding. Moreover, as TFSA contributions are limited each year, it may take years for your portfolio to recover if you lose vast sums of money.

What to hold in a TFSA?

You can avoid taking risks in your TFSA by focusing on quality and valuation. In an ideal world, you would want the TFSA portfolio to derive inflation-beating returns and accelerate your retirement plans.

Canadian Natural Resources$80.861,088$0.90$979.2Quarterly

One way to reach your financial goals is by investing in quality dividend stocks such as Canadian Natural Resources (TSX:CNQ). If you have never contributed to a TFSA, your cumulative contribution room would be around $88,000 today. Given CNQ stock offers a tasty dividend yield of 4.5%, an investment of $88,000 would allow you to earn close to $4,000 annually in dividends.

In the second quarter (Q2) of 2023, Canadian Natural Resources reported adjusted funds flow of $2.7 billion, demonstrating the advantage of its diverse and balanced asset base. Due to its robust cash flow generation, the company has returned $4.3 billion to shareholders via dividends and buybacks.

The company is targeting strong production volumes and free cash flow in the second half of 2023, as it moves toward reducing net debt levels to less than $10 billion. Once CNQ meets its debt level targets, it will return 100% of free cash flow to shareholders.

Its solid financials, top-tier reserves, and asset base provide Canadian Natural Resources with unique competitive advantages in terms of capital efficiency and flexibility, which should support higher dividend payouts.

In March 2023, CNQ increased its quarterly dividend to $0.90 per share, which was the 23rd consecutive year of dividend increases, reflecting the sustainability of its business model and the strength of its long life, low decline asset base.

The company ended Q2 with a net debt balance of $12 billion and liquidity of $5.6 billion, providing CNQ with enough room to pursue capital growth projects which should drive future cash flows and dividends higher.

Priced at 12 times forward earnings, CNQ stock is quite cheap and trades at a discount of 12% to consensus price target estimates. After adjusting for dividends, total returns are closer to 17%.

The Foolish takeaway

Canadian Natural Resources is a quality blue-chip TSX stock that has increased dividends at an annual rate of 20% in the last two decades, which is quite exceptional for a cyclical company. Moreover, CNQ stock has returned 1,790% to shareholders since August 2003 after adjusting for dividends, easily crushing broader market returns.

Despite its outsized gains, investing such a huge sum in a single stock is quite risky. You need to identify similar companies with widening margins and strong financials to diversify your TFSA portfolio and lower investment risk.

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 Aditya Raghunath has no position in any of the stocks mentioned. The Motley Fool recommends Canadian Natural Resources. The Motley Fool has a disclosure policy.

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