Do you want to build long-term wealth in a tax-free savings account (TFSA) starting with just $28,000?
If so, you need a strategy to get you there.
Simply picking stocks randomly will not work – studies show that only 2% of stocks produce most of the long-term returns earned by market participants.
So, you need a diversified portfolio of assets that are likely to perform well. In this article, I’ll share a $28,000 TFSA-building strategy for long-term wealth.
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Diversification
The first principle for building long-term wealth in a TFSA is diversification. If you hold just one stock, you take on a lot of risk specific to that one company. On the other hand, if you diversify across a broad basket of stocks – let’s say all the stocks in the TSX Composite Index – then you reduce your risk significantly. Amazingly, you do not lower your likely returns by managing risk in this way, because one randomly chosen stock will likely perform worse than average. It is only after extremely long and gruelling research that a person might identify a truly superior individual stock opportunity, and that is probably best left to the professionals.
So, how do you diversify your portfolio?
You can try buying all of the stocks in the TSX or the S&P 500 individually, but that’s more trouble than it’s worth. You’ll spend more money on trading commissions (including bid-ask spread costs) than is worth it. Instead, you should hold a low-cost index fund, either a mutual fund or an exchange-traded fund (ETF).
Index ETFs are diversified stock portfolios that trade on the stock market. If you buy a TSX Composite Index fund, you gain exposure to the entire TSX with just that one fund. In one stroke, you eliminate almost all of the costs that come with trying to build a sufficiently diversified portfolio on your own.
An example asset
An example index fund in which you could invest much of your TFSA portfolio is the iShares S&P/TSX Capped Composite Index Fund (TSX:XIC). XIC is a diversified Canadian ETF that holds most of Canada’s biggest companies, as well as some smaller ones. The fund represents all major sectors, including tech, banking, energy, utilities and retail. XIC has a 2.7% dividend yield. It is highly liquid and widely traded, which reduces trade execution costs. Finally, it charges a mere 0.05% management fee and has a 0.06% management expense ratio (MER). Overall, it is a solid fund that should generate considerable long-term wealth for its holders.
Foolish takeaway
Can you build long-term wealth starting with just $28,000? Absolutely, yes. It will take time. It will take discipline. It will take research. But if you put in the work, you will achieve your goal.
That doesn’t mean that great returns are guaranteed. To the contrary, you may endure prolonged periods of low, no, or negative returns. But if you keep at it over the very long term, you should do well by holding a diversified index fund portfolio in your TFSA. That’s much better than most can say for themselves.
