Did you know that it’s possible to cover your monthly bills using a TFSA alone?
While the official TFSA contribution limit is just $109,000 – too little to pay all of your bills for long – you can grow your TFSA over time.
There are numerous documented cases of Canadians achieving $1 million plus TFSA balances. With prudence and disciplined saving, you could become one of them.
If you’re starting with just $25,000, you might fret that you simply have far too small a balance to have a shot at ever paying all your bills with your TFSA alone. If you’re already retired with $25,000 in your TFSA, that might be the case. If, on the other hand, you are under 40, you may eventually be able to grow your TFSA to the point that it’s paying all your bills. In this article, I describe the strategy that can help you do that.
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Dollar cost averaging
Dollar cost averaging (DCA) is the best way to turn a humble $25,000 TFSA into something substantial.
The way DCA works is, you contribute a little bit to your TFSA each paycheque. Let’s say, $500. If you get paid bi-weekly, that’s $1,000 worth of contributions per month, or $12,000 per year. Over two decades, you could contribute $120,000 by DCA-ing like this.
Of course, you’ll eventually run into the problem of contribution limits. The limit in most years is less than $7,500. But if you were 18 or older in 2009, have resided unceasingly in Canada, and have contributed only $25,000 to date, then you should be able to pull off what I just described. In the scenario described, you’d have $84,000 in contribution room available with $70,000 more being added over 10 years, assuming the annual contribution room bump remains at $7,000.
An illustration of how dollar cost averaging works – and why it’s effective
Let’s imagine that you are a diligent TFSA investor holding a diversified index fund portfolio. Let’s further imagine that you’re considering an investment in the Vanguard FTSE Canada All-Cap ETF (TSX:VCN). VCN has a 0.06% management expense ratio, exposure to a wide variety of different industries, and 215 stocks – a considerable amount of diversification. It’s exactly the type of fund that prudent investors tend to invest in.
Now, if you just invest $25,000 into VCN all in one lump-sum, then you could potentially see all your existing savings lost in a market crash.
If, on the other hand, you avoid investing in funds altogether, because you’re scared of a market crash you think is coming, then you risk having your $25,000 go nowhere.
Sounds dire, right?
It does sound that way, but luckily, the DCA method is here to save the day for you. If you invest a little bit from every paycheque you bring in, then you’ll eventually end up with the average price during your holding period, as your average cost. Given the long-term tendency of stocks to deliver positive, even high returns, this should get you a good result with a fund like VCN.
Of course, nothing is foolproof. The markets could stay down over the medium term, increasing the time it takes for the DCA strategy to pay off. But over the long term, it has a high probability of working.
