The TFSA, or Tax-Free Savings Account, is among the most popular registered accounts in Canada. While the TFSA can be used to create long-term wealth, just a handful of Canadians realize the potential of the investment account.
You can use the TFSA to hold a variety of qualified investments that include stocks, bonds, mutual funds, and exchange-traded funds (ETFs). It also offers investors the flexibility to liquidate their holdings easily without having to pay taxes to the CRA (Canada Revenue Agency) on any gains earned in the TFSA.
Basically, the TFSA is an ideal account for short-term or long-term investors. You can invest in short-term bonds, which provide you with a passive-income stream that can be used as an emergency fund. Alternatively, investors can also buy and hold quality stocks in the TFSA to build long-term wealth.
Launched in 2009, the cumulative contribution room in a TFSA has risen to $88,000. Additionally, in recent years, this contribution room has risen by at least $6,000 annually. So, let’s see how you can get your TFSA to $1 million.
The power of compounding
Albert Einstein once famously stated the power of compounding is the eighth wonder of the world. As an investor, it’s advisable to put your savings to work as early as possible. For instance, it will take you 35 years to create a $1 million portfolio if you invest $500 each month, given annual returns of 8%.
But if you delay investments by 10 years, you will have to more than triple your monthly investments to reach the $1 million target.
Aim to maximize TFSA contributions each year
The Canadian government indexes TFSA contributions to inflation. So, the TFSA contribution in 2023 was increased to $6,500 from $6,000 in 2022.
It’s desirable to maximize your TFSA contributions each year. If you are unable to use the entire contribution amount in a single year, it can be carried forward to subsequent years.
Canadians can employ multiple strategies to reach their financial goals. You can invest in ETFs that track indices such as the S&P 500, which has returned 14% annually in the last 14 years.
Let’s assume you have the flexibility to invest $88,000 in the TFSA. Moreover, if you increase TFSA investments by $500 each month, you should reach the $1 million target within 18 years, given annual returns of 14%.
Similarly, if the S&P 500 can continue to deliver these returns, your $88,000 will increase to $628,139 in the next 14 years. In this period, a monthly investment of $500 would balloon to $306,427, taking your portfolio value to almost $935,000.
What should you hold in a TFSA?
Investors should create a diversified TFSA portfolio with an ideal mix of stocks, ETFs, and bonds. A young investor can have a higher exposure to equities, while you may want to hold low-risk asset classes such as fixed-income securities if you are nearing retirement.
An investor who is 30 years old can allocate about 20% to bonds and 60% to ETFs. The rest can be used to buy quality blue-chip stocks such as Apple (NASDAQ: AAPL).
In the last 10 years, Apple stock has returned over 1,000% to shareholders after accounting for dividends. Valued at a market cap of almost US$3 trillion, Apple is the largest publicly traded company in the world and enjoys a wide economic moat. It continues to expand its product line and has successfully monetized its wide base of hardware users.
Further, investors with a larger risk appetite can invest up to 5% in spot Bitcoin ETFs trading on the TSX. Bitcoin prices have surged a staggering 25,000% in the last 10 years and can soon surpass all-time highs in the upcoming bull run.
