Using the TFSA (Tax-Free Saving Account) is a great way to maximize your portfolio returns over time. The TFSA protects you from tax. By not paying tax on your income, you can improve your annual returns by 100 to 400 basis points. Over years and decades, that can add up to a substantial amount of wealth.
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Don’t waste your TFSA on a savings account
Opening a TFSA is one of the best steps a Canadian can take to enhance their wealth. Unfortunately, many Canadians simply use the TFSA as a high interest savings account. While there is nothing in itself wrong with earning 2% to 3% interest, the value of that capital will largely degrade over time due to inflation.
You are hardly maximizing the power of tax-free compounding when you only use the TFSA as a savings account. Investing in stocks is by far the better use. You want to find investments that can create substantial income and gains. Why? Simply, you don’t want to pay any tax on those massive gains.
That is why the TFSA is such a home run for patient long-term investors. If you are wondering how to turn a $20,000 TFSA investment into $100,000 (or more), here are a couple of examples.
Hammond Power: A top Canadian small-cap stock
Small-cap stocks are a wonderful place to look for fast 5 times and 10 times returns for your TFSA. One small-cap stock that has delivered incredible returns is Hammond Power Solutions (TSX:HPS.A).
Hammond is a leading provider of specialized power transformers that are used in everything from data centres, manufacturing facilities, and car charging stations to renewable power facilities. You only need to contemplate electrification and digitization trends to consider that this stock could have some serious tailwinds.
Indeed, over the past three years, it has delivered 20% compounded annual revenue growth (CAGR). Earnings per share have rocketed by a 50% CAGR. Since the pandemic, demand for its products has rapidly scaled.
Despite all the positive developments, HPS.A stock was trading for less than 10 times forward earnings in late 2022. Since December 2022, it has risen 517%. That is a 5 times return in just two years and eight months.
You would have had to dig a little to find this gem of a stock for your TFSA. However, a strategic and patient investment in Hammond would have quickly turned $20,000 to $100,000.
TerraVest: A millionaire-making TFSA stock
Another stock that could have quickly 5 times TFSA investors capital is TerraVest Industries (TSX:TVK). There is nothing overly exciting about this business. It manufactures specialized tanks, trailers, and boilers.
However, many investors didn’t realize that this business was doing something unique. It could acquire smaller manufacturing businesses at very cheap valuations. When implemented into its manufacturing system, it unlocked substantial synergies and drastically improved profitability.
It had a large market to consolidate (and still does). Yet, TerraVest only traded for 11.5 times earnings in 2022. Had you bought it in February 2022, you would have enjoyed a 522% return in three years and seven months!
The Foolish takeaway
Using your TFSA as a savings account misses the entire point of the account. When you invest in stocks, you can use the TFSA as a compounding machine. When you add small, growing companies at attractive valuations, you can see your capital multiply very quickly. Stocks like Hammond and TerraVest are not easy to find. However, if you make the effort to search for them, the reward can be outsized.
