The Bank of Canada (BoC) just raised its benchmark interest rate by 0.25 percentage points to 2.50% on Oct. 28, marking its first rate hike since 2023. With inflation risks resurfacing, Canadian investors may need to rethink where they park their Tax-Free Savings Account (TFSA) money.
BoC governor Tiff Macklem explained that the increase is intended to prevent elevated global oil prices from spreading into broader inflation. He also signaled that another hike remains possible if inflation proves persistent.
For investors, this creates an opportunity to favour financially resilient businesses that can benefit from higher interest rates while continuing to grow their earnings and dividends. Two stocks worth considering are Royal Bank of Canada (TSX: RY) and Sun Life Financial (TSX: SLF).
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Royal Bank: A quality dividend stock with long-term potential
Canadian banks can benefit from higher interest rates through improved net interest margins, although the impact depends on deposit costs, lending demand, credit quality, and the broader economic environment.
Royal Bank is a top candidate for long-term TFSA holding. As one of Canada’s largest financial institutions, it has diversified banking operations, established competitive advantages, and a dependable dividend-growth record.
At approximately $288 per share, Royal Bank offers a dividend yield of 2.4%, backed by a 15-year dividend growth rate of 7.6%. These characteristics make it appealing to investors seeking a combination of income and capital appreciation.
Notably, Royal Bank shares have surged 244% over the past three years, delivering exceptional total returns of approximately 70% annually with dividends reinvested. Such performance makes chasing the stock less attractive.
Analyst consensus suggests the shares are fairly valued, meaning future returns will likely depend more heavily on earnings and dividend growth than further valuation expansion. I’d consider accumulating shares gradually, particularly during market corrections that offer a more attractive entry point.
Sun Life: Another financial stock worth watching
Sun Life offers a different way to benefit from the financial sector. As a leading life and health insurer, it can benefit from higher interest rates through improved investment yields on new fixed-income purchases and reinvested portfolio assets.
Insurers manage substantial pools of policyholder reserves, investing in bonds, mortgages, and other income-generating assets. Higher reinvestment yields can strengthen investment income over time. Rising rates can also improve the economics of certain insurance and annuity products, although the overall impact depends on asset-liability matching and market conditions.
At approximately $214 per share, Sun Life offers a dividend yield of nearly 3.3%, alongside an impressive 10-year dividend growth rate of 8.8%.
Like Royal Bank, Sun Life appears fairly valued based on analyst consensus. Its combination of dividend income, established operations, and potential earnings growth makes it a top candidate for long-term TFSA investors.
Both companies are expected to grow earnings per share by at least 8% annually over the next few years. If those forecasts materialize, approximate annual returns of 10% for Royal Bank and 11% for Sun Life are possible, including dividends, assuming valuations remain relatively stable.
The Foolish bottom line
I’d consider Royal Bank and Sun Life for a diversified, income-producing TFSA portfolio. However, investors shouldn’t overlook companies with manageable debt, strong balance sheets, and earnings growth comfortably exceeding inflation.
The key is not simply betting on higher interest rates. It’s owning quality businesses capable of delivering sustainable earnings and dividend growth at reasonable valuations. I’d keep some cash available to capitalize on market pullbacks rather than rushing to invest everything today.
