Are You Using Your TFSA the Right Way? Many Canadians Aren’t

A TFSA offers powerful benefits, so it’s best not to waste them on low-returning investments.

Key Points
  • Using a TFSA exclusively for GICs or cash may not be the best use of limited tax-free contribution room.
  • TFSA, RRSP, FHSA, and non-registered accounts all have their place depending on your financial goals and tax situation.
  • XEQT provides a globally diversified, low-cost, 100% equity portfolio that is well suited for long-term tax-free compounding.

The Tax-Free Savings Account (TFSA) is one of the best investing tools Canadians have. Unfortunately, many people use it in one of the least effective ways possible. They fill it with guaranteed investment certificates (GICs) because of the word “savings” in the name.

For an emergency fund, that approach is perfectly reasonable. But that emergency fund does not necessarily need to sit inside your TFSA. Sheltering a roughly 2.5% savings rate or GIC yield from income tax is nice, but TFSA contribution room is limited. Once it is used, it becomes much harder to shelter larger long-term gains from taxes.

Personally, I would rather save that valuable tax-free space for investments that have the potential to compound significantly over many years. In other words, do not waste premium tax shelter on modest interest income if you can use it for much bigger fish.

ETF stands for Exchange Traded Fund

Source: Getty Images

When should you use a TFSA?

The answer depends on your situation. For many Canadians, the TFSA should be one of the highest priorities because investment growth and withdrawals are completely tax free.

That said, there are exceptions. Higher-income earners may benefit more from prioritizing a Registered Retirement Savings Plan (RRSP) because of the upfront tax deduction. Canadians saving specifically for their first home should also consider the First Home Savings Account (FHSA), which combines many of the advantages of both the TFSA and RRSP.

The important point is that TFSA contribution room is limited. For 2026, Canadians received another $7,000 worth of contribution room. While saving enough to maximize that annual limit is not always easy, the target itself is manageable for many households with consistent saving habits. The sooner those contributions are invested, the longer tax-free compounding has to work.

A simple ETF for long-term compounding

If the goal is maximizing long-term growth, one of my favourite options is the iShares Core Equity ETF Portfolio (TSX: XEQT).

XEQT takes an extremely simple approach. It maintains a 100% equity portfolio spread across thousands of companies in Canada, the United States, international developed markets, and emerging markets through several underlying index funds. The ETF automatically maintains its target geographic allocation, so investors never need to decide which country or region deserves more money.

Costs remain low as well. XEQT charges a management expense ratio (MER) of approximately 0.20%, or $20 in annual fee drag per $10,000 invested, allowing investors to keep more of their long-term returns.

For investors with decades before retirement, the strategy can be remarkably uncomplicated. Buy regularly, reinvest the distributions, and buy more shares every time additional TFSA contribution room becomes available. Then leave the ETF alone and let compounding do the heavy lifting over the long term!

Fool contributor Tony Dong has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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