Are you wondering how to invest the $21,000 you happen to have lying around?
If so, putting the money into a Tax-Free Savings Account (TFSA) is one of the best decisions you can make. TFSAs shelter all of your returns (income and capital gains) from taxation. There’s a limit to how much you can contribute; however, depending on your age, it could be as much as $102,000. Unlike Registered Retirement Savings Plans, TFSAs do not become taxable when you withdraw funds from them. So, they offer a lot of tax-saving power. In this article, I reveal a simple three-step process to build a $21,000 TFSA that generates growing income.
Step #1: Asset allocation
If you want to generate growing income in a TFSA, you need to choose assets that lend themselves well to that. Generally speaking, Guaranteed Investment Certificates (GICs) and other bonds don’t make the cut: their annual payouts usually remain the same over time. There are some exceptions, such as step-up bonds, but they are fairly esoteric instruments most investors will struggle to access.
To generate growing income in your TFSA, there are two types of assets you can buy:
- Dividend-paying stocks.
- Dividend exchange-traded funds (ETFs).
Dividend stocks are shares of companies that periodically pay out a portion of their profits to investors, typically quarterly. Dividend ETFs are diversified investment funds built on portfolios of dividend stocks.
The virtue of dividend stocks, when compared to bonds, is that dividend income can grow over time. It doesn’t always grow over time, but if you successfully find thriving companies to own stock in, you’ll typically see the dividends rise. With that out of the way, here’s how to find high-quality dividend stocks.
Step #2: Security selection
Finding high-quality individual dividend stocks is a tricky business: generally speaking, most investors should go with dividend index funds instead. However, there are some individual dividend stocks that have stood the test of time and are widely praised by Canada’s best investors.
Consider Fortis (TSX:FTS), for example. When it comes to TSX stocks that generate growing income, this is among the best in its class. The company has raised its dividend payout every year for 51 years straight, making it a dividend knight. The company is growing modestly, with earnings up 5.8% and revenue up 3.3% in the trailing 12-month (TTM) period. It’s also highly profitable, with a 45% gross margin and a 15% net income margin. As a utility, it enjoys a high level of government protection and revenue stability. Finally, although Fortis operates in a debt-heavy industry, its debt-to-equity ratio is a fairly modest 1.2. So, this stock could be worth owning.
Step #3: Re-investment
Once you’ve selected some quality dividend stocks/ETFs for your portfolio, the only step left is to re-invest the payment. You can usually set this up automatically through your broker or even the issuing company. By re-investing, you sometimes get to buy shares at discounted prices. So, make sure you re-invest your dividends. It can go a long way toward building a $21,000 TFSA into something more substantial.
