Identify qualities of the best ETFs, including diversification across top-quality stocks, so you can hold the best funds for your TFSA investing
Your tax-free savings account (TFSA) allows you to earn investment income, including interest, dividends, and capital gains, tax-free. Do you know how to incorporate the best ETF for TFSA investing success? Exchange-traded funds, otherwise known as ETFs, are a great way for investors to own a wide range of stocks with a single investment. Exchange-traded funds are also eligible for the Canadian dividend tax credit, although this only applies to ETFs that pay dividends generated from Canadian stock holdings. TFSA investing tips: Consider using ETFs in your TFSA to benefit from diversification, lower risk, and flexibility.
What you need to know about TFSAs to get the greatest benefits
The federal government first made the tax-free savings account (TFSA) available to investors in January 2009. Holding higher-risk stocks in your TFSA is a poor investment strategy. That’s because high-risk stocks come with a greater risk of loss. If you lose money in a TFSA, you lose both the money and the tax-deduction value of the loss. (Outside your TFSA, you can use capital losses to offset taxable capital gains.) You’ll also lose the main advantage of a TFSA: sheltering gains from tax. You won’t have gains to shelter if the value of your investments falls. We think you are best to hold lower-risk investments in your TFSA. That’s because you don’t want to suffer big losses in these accounts. If you do, as mentioned, you can’t use those losses to offset capital gains. You’ll also lose the main advantage of a TFSA: sheltering gains from tax. You won’t have gains to shelter if the value of your investments falls. If you are just starting a TFSA, you can’t yet build a diversified portfolio within your account. That’s why you are best to hold lower-risk and low-fee investments like ETFs. You could also hold interest-bearing investments, like high-yield savings accounts or index funds. TFSA investing tips: Focus on lower-risk investments in your TFSA to avoid losing the tax advantages.
Discover how to pick the best ETFs for TFSA investing growth
When you are first starting out with your TFSA, or making small monthly contributions, you could look to low-fee index funds for TFSA investing. Over the years, as the value of your TFSA increases, you could switch those funds into a well-diversified portfolio of conservative, mostly dividend-paying stocks. Exchange-traded funds (ETFs) can play a role in a TFSA. Using ETFs for growth within a TFSA is one popular long-term investing strategy. TFSA investing tips: As your TFSA grows, gradually transition from low-fee index funds to a diversified portfolio of conservative dividend stocks or ETFs.
TFSAs are a bit different than registered retirement savings plans (RRSPs) because contributions to them are not tax-deductible. Withdrawals from a TFSA, however, are not taxed.
The best ETFs for TFSA growth will also provide you with a low-cost way to increase your exposure to top-quality stocks.
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One good example is the iShares S&P/TSX 60 Index ETF (Toronto symbol XIU). The fund’s units are made up of stocks that represent the S&P/TSX 60 Index, which consists of the 60 largest, most heavily traded stocks on the exchange. Most of the stocks in the index are high-quality companies. You may pay a commission to buy this fund (through a broker), but the fund’s yearly expenses are just 0.18% of assets.
Look for these three positive traits, and you can find the best ETFs for TFSA investing
To sum up, here’s why we recommend the use of ETFs in your TFSA:
- ETFs diversify a portfolio. You could build a diversified portfolio of conservative, mostly dividend-paying stocks spread out across the five main economic sectors (Manufacturing & Industry, Resources, Finance, Utilities and Consumer).
- Traditional ETFs are lower risk. Holding higher-risk stocks in your TFSA is a poor investment strategy because they come with a greater risk of loss. If you lose money in a TFSA, you lose both the money and the tax-deduction value of the loss. So stick with lower-risk stocks or ETFs that hold those stocks
- ETFs are flexible. If funds are limited, you may need to choose between TFSA and RRSP contributions, but ETFs can be used for either.
Use our three-part Successful Investor approach to add the best stocks (or ETFs that hold those shares) for TFSA investing success to your portfolio
- First, invest mainly in well-established, mostly dividend-paying companies.
- Second, avoid or downplay stocks in the broker/media limelight.
- Third, spread your money out across the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities).
By following these TFSA investing tips, Canadians can work towards building a successful, tax-efficient investment portfolio.
In summary, this article provides valuable TFSA investing tips for Canadians looking to maximize the benefits of their tax-free savings accounts. It emphasizes the importance of holding lower-risk investments, such as ETFs, in a TFSA to avoid significant losses and to take advantage of the main benefit of a TFSA: sheltering gains from tax. The article recommends starting with low-fee index funds when first contributing to a TFSA and gradually transitioning to a well-diversified portfolio of conservative, dividend-paying stocks as the account value grows. It highlights the iShares S&P/TSX 60 Index ETF as a good example of an ETF that provides exposure to high-quality stocks at a low cost. The article also outlines a three-part investing approach, which includes investing in well-established, dividend-paying companies, avoiding overly hyped stocks, and diversifying across the five main economic sectors. By following these TFSA investing tips, Canadians can work towards building a successful, tax-efficient investment portfolio.
The CRA plans to “crackdown” on instances of alleged abuse with TFSAs. How do you feel about this? What is the best move you’ve made in TFSA investing?
This post was originally published in November 2012 and is regularly updated.
