Canadian investors can use the TFSA (Tax-Free Savings Account) to earn tax-free income and grow their wealth. The TFSA preserves investments like stocks, bonds, mutual funds, and ETFs (exchange-traded funds) from being charged tax on capital gains, interest, and dividend income.
No tax to pay and no reporting either
Since no income is taxable, you aren’t required to report your TFSA income to the CRA (Canada Revenue Agency). If all your investments are in the TFSA, it can really simplify tax season. So long as you follow all the TFSA contribution and trading rules, it can be a great account to grow and compound your wealth.
If you were 18 years or older in 2009 and were a Canadian resident, you could contribute a grand total of $88,000 in 2023. That contribution limit will increase to $7,000 in 2024, so that will be a grand total of $95,000 you can invest tax-free in your TFSA.
How to turn $95,000 of TFSA cash into $420,000
When you don’t pay tax, you keep all your returns. As a result, your wealth can compound significantly faster than other accounts. $95,000 that earns 8% annually on a diversified portfolio (like the S&P 500 Index) could double in value in 10 years or less.
If you could double that average return to 16% per year, the value of your portfolio would hit closer to $420,000 in a decade. That is a $325,000 capital gain (if you sold) that the CRA won’t tax.
That is why the TFSA is the ideal place to hold stocks that you believe could be long-term winners. You don’t want to pay tax on big income returns. If you are wondering what kind of stocks to hold in your TFSA, two ideas to dig into further are below.
A top software stock for a TFSA
Topicus.com (TSXV:TOI) is not a well-known company in Canada. However, it is one of the largest specialized software consolidators in the Netherlands and Europe.
Topicus was spun out from Constellation Software only a few years ago. If you weren’t aware, Constellation’s stock has returned a 33% compounded annual rate of return over the past decade. Topicus is looking to replicate the same software acquisition strategy but primarily in Europe.
The European software market is highly fragmented due to language, cultures, government, and jurisdictional differences. As a result, Topicus has a large opportunity to grow in the space.
Topicus has a higher focus on organic growth than Constellation, so it could deserve to trade at a premium. For a long-term, buy-and-hold growth stock, this is a great business for a TFSA.
An underfollowed Canadian compounder
Another interesting TFSA stock for long-term capital gains is TerraVest Industries (TSX:TVK). This stock is even less known than Topicus.com. TerraVest owns a mix of industrial companies focused on energy, heating, infrastructure management, and transportation services.
Its companies are not fancy businesses. However, they tend to generate a lot of cash, and TerraVest has the operating expertise to maximize profits. TerraVest stock has earned a 30% compounded annual total return over the past decade.
Despite such strong growth metrics, this stock only trades for 16 times earnings. The company continues to execute well and has ample acquisition opportunities ahead. If you don’t mind looking in the weeds, this is a good stock for compounding returns in your TFSA.