August 6, 2009, 5:28 am

2 Things I Would do With My TFSA Account

by: The Financial Blogger    Category: Financial Planning
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We just entered August this week and you haven’t opened your TFSA account? What are you waiting for? The TFSA (Tax Free Savings Account) has been in place since the beginning of 2009, sponsored by the Canadian Government. While I had already described the program in a previous post, here are the major things to remember:

– You are allowed to invest $5,000 per year regardless of your income (must be 18 year old to participate).

– You are not restricted in the type of investment (CD’s, mutual funds, stocks, Canadian and International assets, etc.)

– All gains within the TFSA are, quite obviously: Tax Free.

– Contributions and withdrawals have no tax implications (therefore no tax deductions and payments are not tax deferred… simply tax free).

Actually, the only bad thing about the Tax Free Savings Account is the size of the contribution at first. It’s fun to save $5,000 with all growth free of taxes but what can you really do with such small amounts? If you buy a certificate of deposit, the interest earned will be insignificant (especially considering the current low interest rate environment!). With a 5 year rate at 3.5%, you would actually earn $175 per year of interest. Meaning, you actually save an astonishing $70 a year with a 40% marginal tax rate. That’s it; you could retire 5 years earlier with this new strategy… NOT! The good news is that amount will increase over time (the $5,000 yearly limit will be eventually be adjusted to match the inflation rate). In the meantime; here’s what I would do with my TFSA:

#1 Holding liquidity in your TFSA

As you already know, I am not a big fan of emergency funds. I prefer the use of a line of credit instead of “freezing” 5K to 10K. Since personal finance has no absolute, if you feel more comfortable seeing a monthly statement showing you have an emergency fund, the TFSA is definitely an answer to your need.

Liquid and secured assets will generate interest income. And interest income is fully taxable at your marginal tax rate. So if you want to protect your emergency fund from inflation, consider investing in a TFSA so the interest income remains tax free. Since you can withdraw this amount at any time, this fulfills all the requirements for a good emergency fund.

Since interest rates are pretty low right now, I would be tempted to look at mortgage-based mutual funds to allow for better investment returns. They usually offer a 3 to 5% expected investment yield and show small to no negative fluctuations. Currently many of them may, within a 12 month period, show a negative return. However, this should not exceed 3 to 4%. What is 4% of $5,000? $200. You should be able to support a temporary loss of $200 even in a case of an emergency. On the other hand, if chances of using your emergency funds are low over the next 2-3 years your investment yield will be far better than regular certificates of deposit.

#2 Following an index

If you do not need your money right away and you want the potential for even better returns, you are running out of options. With $5,000, you would be limited when looking at stocks, buying 2 – 3 stocks (of 100 shares each). In fact, you could barely buy a basket of Canadian bank stock!

On the other side, you could easily find an ETF or an index mutual fund that replicates the market. I like them since they get you the best from the market (growth!) without cutting returns with astronomical management fees. Depending on the amount you want to place, index mutual funds may become your best option at the beginning.

Since there are no transactions fees (no commission on the buy or sell side of the product) and relatively low MERs (usually around 0.50%), it may be the best solution for a $500 to $5,000 investment. You can also contribute to it with a systematic investment plan as well (which you wouldn’t want to do with ETFs as they charge a commission for each transaction). Unfortunately, you will also have to live with the fluctuation of both types of products. When the market is down 35%… your investment will reflect it as well…

Do you have any other investments you would like to include in your TFSA?

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When the total equity with the discount broker (in all trading accounts put together) is over a set amount (50K for some) the commissions are lower. I’ve read a comment once in one of the financial blogs about someone who boasted investing in quite a few penny stocks and doing very well overall.

I don’t have that luxury, so just bought SPB.TO (about 15% dividend yield, in monthly payments – used to be a trust unit) at $10.21 (now around $11), and – so far so good…;range=ytd;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined

Actually, my TFSA is holding dividend paying companies such as ala.un. I am averaging about 13% a year. The good part is to use a promo with questrade and all your inital fees are reimboursed. I will re-evaluate in H1 2010.

I’ve invested in high paying dividend stocks (PWT.UN, MRF, TRP) with the market rise since march, my 3800 in so far is almost 5000.. not bad i’d say!

high paying dividend stocks were quite a deal back in Januray!

With the TFSA amount increasing by 5K a year, this will become one of the most interesting strategies (now that stocks went higher, buying them become a bit rough with only 5K…)

great trades guys!

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This is very interesting. TFSA account is looking good enough. I am thinking about it and may be I will hold an TFSA account soon.
Anyway, Thank you for sharing some good information about TFSA account.

Mind you don’t over-contribute to your TFSA or you will be subject to a 1% per month penalty.

[…] The Financial 2 things I would do with my TFSA account. “We just entered August this week and you haven’t opened your TFSA account? What are you waiting for?” […]