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TFSAs let you earn investment income — including interest, dividends and capital gains — tax free. You could only invest $5,000 this year to start your TFSA. However, you gain an additional $5,000 of contribution room (indexed to inflation and rounded to the nearest $500 on a yearly basis) every year, plus you get to carry forward unused contribution room from previous years. (So in 2010 you’ll have $10,000 of contribution room, $15,000 in 2011, and so on.)

Use your tax free savings account to complement your RRSP

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iShares CDN MSCI EAFE Index Fund, $16.33, symbol XIN on Toronto (Shares outstanding: 50.6 million; Market cap: $825.5 million), is an exchange-traded mutual fund that tries to match the return of the Morgan Stanley Capital International Europe Australasia Far East (MSCI EAFE) Index. The MSCI EAFE Index is a benchmark for international equity performance. It is made up of 21 MSCI country indexes representing the developed markets outside of North America: Europe, Australasia and the Far East. The iShares CDN MSCI EAFE Index Fund is hedged against movements of foreign currencies against the Canadian dollar. The fund’s value rises and falls with the price movements of the stocks in its portfolio. The fund’s top 10 holdings are: BP plc, HSBC Holdings plc, Nestle SA, Total SA, Toyota Motor, Vodafone Group plc, Roche Holding, Telefonica SA, Banco Santander SA and BHP Billiton Ltd....

ISHARES DIVIDEND INDEX FUND $16.92 (Toronto symbol XDV; buy or sell through a broker) currently holds the 30 highest yielding Canadian stocks. Stocks are included in the index based on their dividend growth, yield and average payout ratio. The weight of any one stock in the fund is limited to 10% of the fund’s assets. iShares Dividend Index Fund’s MER is 0.50%. The fund now yields 4.8%. The fund’s top holdings are: National Bank of Canada, 8.9%; Bank of Montreal, 8.0%; CIBC at 7.2%; TD Bank, 6.3%; IGM Financial, 5.0%; Bank of Nova Scotia, 5.0%; Royal Bank of Canada, 4.9%; Manitoba Telecom 4.6%; TMX Group, 3.6%; Sun Life Financial, 3.2%; Power Financial Corp., 3.2%; Telus Corp., 3.1%; and Russel Metals, 2.8%....

Theme funds are funds that focus on investments in broad areas, such as alternative energy, health, science, resources or whatever. These funds often suffer from pseudo-diversification. That is, they have lots of different stocks in their portfolios, but these stocks all respond to the same economic factors. What’s more, many theme-fund managers gravitate toward speculative stocks and recent new issues, two areas that harbour more than their share of disasters. That’s especially so when the theme comes out in response to a boom in the theme where it wishes to invest. Of course, theme funds can prosper for months or years. But they rarely generate enough profit to justify their underlying risk. We don’t recommend any of the four alternative-energy funds we analyze below....

ISHARES CANADIAN SHORT BOND INDEX FUND $29.34 (CWA Rating: Income) (Toronto symbol XSB; buy or sell through a broker) mirrors the performance of the DEX Short-Term Bond Index. This index consists of a wide range of investment-grade federal, provincial, municipal and corporate bonds with between one- and five-year terms to maturity. The iShares Canadian Short Bond Index Fund currently holds 152 bonds with an average term to maturity of 2.9 years. Top issuers include the Government of Canada, Canada Housing Trust, Bank of Nova Scotia, the Province of Ontario and the Province of Quebec. The bonds in the index are 68.4% government and 31.6% corporate....

ISHARES CANADIAN BOND INDEX FUND $29.23 (CWA Rating: Income) (Toronto symbol XBB; buy or sell through a broker) mirrors the performance of the DEX Universe Bond Index. This index consists of a wide range of investment-grade Canadian government and corporate bonds with terms to maturity of more than one year. The 221 bonds in the fund’s portfolio have an average term to maturity of 8.7 years. The bonds in the index are 71.2% government and 28.8% corporate. The fund sticks with high-quality government bonds from issuers such as Canada Housing Trust, Government of Canada and Province of Ontario, plus high-quality corporate bonds from issuers such as Bank of Montreal, TransCanada Pipelines, Bank of Nova Scotia, Great-West Lifeco and Bell Canada....

With interest rates so low, bonds have become much less attractive to income-seeking investors. However, if you need stable income and want to hold bonds, here are two bond funds that have low fees and top-quality holdings. As well, both cut risk by avoiding speculative trading and emphasizing government bonds. ISHARES CANADIAN SHORT BOND INDEX FUND $29.34 (CWA Rating: Income) (Toronto symbol XSB; buy or sell through a broker) mirrors the performance of the DEX Short-Term Bond Index. This index consists of a wide range of investment-grade federal, provincial, municipal and corporate bonds with between one- and five-year terms to maturity. The iShares Canadian Short Bond Index Fund currently holds 152 bonds with an average term to maturity of 2.9 years....

We still think high-quality mutual funds with a long-term focus will beat stock-market indexes over time. If funds invest as we advise — sticking with well-established companies and spreading their assets across the five main economic sectors — they will likely lose a lot less than the indexes during a significant market downturn. That’s because big market slides are particularly hard on the stocks that were the most popular during the preceding rise, and our approach avoids excessive investment in these companies. In contrast, index funds do tend to load up on the hottest, most popular stocks as they rise. That’s because these stocks make up a growing proportion of the index as they increase in value. The most recent example is Potash Corporation of Saskatchewan, which, propelled by soaring fertilizer prices, had the highest market capitalization on the Toronto exchange last June. The shares have since dropped 54%....

ISHARES MCSI CANADA INDEX FUND $20.94 (American Exchange symbol EWC; buy or sell through brokers) is like a market-cap-based index fund, but its managers tinker with the index-fund formula in order to try and improve performance. They do this using their proprietary Morgan Stanley Capital International Canada Index. The U.S.-based fund also has to work around Canadian foreign-ownership restrictions. iShares MCSI Canada Index Fund is managed by Barclays Global Investors and has an MER of 0.52%. If you want to own a Canadian index fund, you should buy the iShares CDN LargeCap 60. You’ll pay about a third of the management fees. We don’t recommend iShares MCSI Canada Index Fund.

ISHARES CDN LARGECAP 60 INDEX FUND $15.54 (Toronto symbol XIU; buy or sell through a broker) (units split 4-for-1 in August 2008) is a good, low-fee way to buy the top stocks on the TSX. The 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. Expenses on the units are just 0.17% of assets. Most of the stocks in the index are high-quality companies. However, as it must ensure that all sectors are represented, the index holds a few we wouldn’t include, such as Biovail Corp. The index’s top holdings are: Royal Bank of Canada, 7.2%; EnCana Corporation, 5.2%; Research in Motion, 5.2%; TD Bank, 4.9%; Bank of Nova Scotia, 4.2%; Manulife Financial, 4.0%; Potash Corporation, 3.9%; Canadian Natural Resources, 3.7%; Suncor Energy, 3.7%; Barrick Gold, 3.7%; Goldcorp, 2.9%; Canadian National Railway, 2.8%; Bank of Montreal, 2.6%; and CIBC, 2.5%....