What is a TFSA?
Investing can be a pretty scary prospect for a lot of people. It’s often easier to just park our money in our chequing or savings accounts keeping an eye out for a rainy day. Unfortunately, with the current interest rates offered by banks in Canada you’ll make practically nothing doing this. In fact, you could even lose money when inflation is accounted for.
So investing is the most effective way to make your money work for you outside of taking advantage of the money laundering fueled property price boom. The cost of entering the property market however is significantly higher than starting your own investment portfolio.
Thanks to the Tax Free Savings Account or TFSA, Canadians have a great vehicle to make sensible investment decisions with the awesome added benefit of not having to pay tax on withdrawals from the account.
What we’re doing
In this article, we’re going to go through the process of starting a TFSA, who/how we’re doing it and why. Then over the course of the next year we will update you every month on our contributions and investment decisions.
We’ll be going on this (hopefully not too) wild investment ride together, and hopefully end up with a tidy sum of extra cash at the other side. We can’t guarantee that we won’t wildcard and dump $15,000 into bitcoin in 6 months time but look, the journey is as important as the destination…
Without wasting anymore time, let’s get into the meat of what TFSAs are.
What is a TFSA/Contribution Room
The TFSA was set up in 2009 to provide those over 18 years of age holding Social Insurance Numbers (SIN) in Canada with a vehicle that would encourage saving and open up investment opportunities. You can see therefore that TFSAs are not just restricted to Canadian citizens and are a tools that the vast majority of working people in Canada can avail of. This can be a great way for immigrants or ‘new Canadians’ to try to build some wealth in their new life.
The idea behind a TFSA is that you can contribute a set amount of your net (after tax) income into an account and any profits you make through the TFSA come back to you mostly tax free. There are some exceptions but in general, as you pay tax on the way in, you don’t pay tax on the way out.
How much money can I put in my TFSA?
This depends. Below is a chart of the total TFSA contribution room up to 2020. If you have worked in Canada with a SIN since 2009 you can theoretically put up to $69,500 into your TFSA. This amount is likely to increase each year at a relatively steady rate.
In addition, if your TFSA grows your total contribution room becomes the new value of your account. For example, if you invest $12,000 into the TFSA and it grows to $15,000, you can take that $15,000 out and your TFSA contribution limit will remain $15,000 instead of $12,000.
Types of TFSA
There are as many ways of configuring a TFSA as there are people with TFSAs but in general there are two broad categories of TFSA: A Saving TFSA and An Investment TFSA. The great news is that you can have multiple TFSA up to the contribution limit combined so you don’t have to make a single choice and be stuck with it.
The safest, most easily accessible, and least productive type of TFSA are the savings accounts. These are low risk products & services that are generally provided to you by a financial institution. Generally speaking they hold your money for you and pay you a set amount of interest over a certain period of time. There are two main types GICs and high-interest savings accounts.
These type of accounts are for savers who don’t want to deal with researching different ways to maximize your returns and just want to have a safe, guaranteed way to grow their money. For that purpose these accounts are great. The price for this safety however is that in the long run you’ll likely to only earn a small fraction of what even the most conservative investment strategy would. This is even accounting for dips in the stock market.
The two primary types of investment TFSA are ‘Savings Accounts‘ and Guaranteed Income Certificates. Both types of TFSA commit to give you a set amount or money over a period of time (Savings Accounts and redeemable GICs) or at the end of a period of time (non-redeemable GICs).
We didn’t consider any particular offer of Saving TFSA for our approach so we don’t have a pick to share with you. That’s not to say that their isn’t a great match for you out there if your risk profile is lower than us here at BearMoney.
For more information on Saving TFSAs, check out a comparison here.
Investment accounts are where the TFSA really shines. Investing your contributions into numerous assets can net you significant sums of money over the long term. In fact, a moderately successfully portfolio over a period of 20 years could see you gain about $58,000 on a maximum contribution of $6,000 per year. Those are good, but not impossible returns. That’s actually less than the stock market in Toronto returned over the last two decades.
Investment TFSAs are simple: you buy securities, derivatives, or commodities through your TFSA provider and you hopefully reap the benefits over time. You can also bundle up with GICs above and even trade cash if you so wish . Like we said, there are as many combinations of these instruments as there are people with TFSAs. Some of the most common investment assets used in Canada are;
Exchange Traded Funds or ETFs are one of the most user friendly and equalizing types of investment products out there. Instead of having to buy individual stocks, getting bogged down in fees or only holding small numbers of shares at any one time, the ETF does all the heavy lifting for you.
The ETF is basically a bundle of several financial instruments including things such as stocks and bonds that a brokerage will collect and offer to investors ate large. This means that instead of buying 15 different stocks you buy a share in the ETF and your investments grow based on the cumulative growth in the ETF itself rather than the individual financial instruments. This is investment on easy mode and the most simple way to grow your dollars outside of the ‘set and forget’ savings accounts and GICs.
With the arrival of ‘roboadvisors’ and eplatforms like Questrade, Wealthsimple, and BMO smartfolio ETFs are accessible, easy to use, and more importantly cheap. The cost of ETFs can be a bit tricky and involves several factors (simple formula here) but basically you can pretty much get away with paying less than 1% in fees for your ETF. This is significantly less than what you’re going to pay in are next big ticket item, mutual funds.
Check out Canadian Couch Potato’s guide to index investing here, to get a good overview of ETFs and similar products.
Mutual Funds are a middle ground financial instrument between ETFs and going solo. A mutual fund is very similar to an ETF in that it contains a group of securities/assets. The difference being that it is managed by a money/fund manager. So, instead of following a set pattern or group of investments, it follows the plan of a individual or groups of individuals.
This has the benefit of providing an opportunity to beat the returns of ETFs by finding hidden growth patterns in stocks etc. In theory, your fund’s money manager is incentivized to make you money (as he/she is usually paid based on profits) and as such you’re possibly going to see significant returns.
The catch is that there is no real guarantee that your fund manager will outperform the comparative ETFs (although you can easily check their record). In addition you’re probably going to look at double the fees of a normal ETF.
So investing in a mutual fund is going to require research and trust in the fund manager. The rewards are there but the workload is higher.
A bond is a fancy name for a loan or an IOU between an entity like a company or government and a investor. Bonds are issued with the aim of providing funding for the entity. Effectively, the entity agrees to pay you a set amount of money over a set period of time if you given them your money right now. They will also give you all of your initial loan back and the end, or maturity, of the bond. This amount is a fixed rate that generally relates to how likely you are to actually get your money back.
In government bonds for example, rich countries like the USA and Germany are essentially guaranteed not to default on their bonds (not pay the agreed amount). As a result they’ll give you very little money, in fact a 1 year US bond will only give you about a %1 return right now.
The problem with bonds is that there is always a risk that you’ll get nothing back from your investment. Especially with governments or large companies, they can effectively go bankrupt and refuse to pay you.
Bonds are an interesting addition to your investment but again, you need to do your research first. A 10% return might sound great until you realize Argentina isn’t going to pay you!
We’ve already heard of stocks/shares, either through our educations or via the news media and hollywood films like Wall Street. Stocks are basically shares of ownership in a company. You pay a set amount and you own a % of the company whose stock you purchased. There are different types of shares which you can buy but they mostly break down into preferred and common stock.
The main difference for the casual investor is that preferred stock tend to have a lower but more stable return over common stock. In addition preferred stock is slightly more advantageous in the event of bankruptcy. Although, in fairness, your chance of getting much from a failed company is pretty low either way.
Buying shares can grow your investments in two ways, share price increases and dividends. A share price increase is exactly what it sounds like, you buy a share at $10 and through market demand it becomes worth $21. You now have made a $10 gain on your initial investment (assuming you can sell the stock of course). A dividend is when a company shares out a percentage of its profits to its shareholders. This is normally less than the entire profit but can generally give you a couple of % return.
It is worth noting that neither dividends nor share price increases are guaranteed to happen. In addition, when you own a share of a single company, over say and ETF or a mutual fund, you are 100% reliant on the success of that firm. If the company loses money you’re likely to get nothing but a decrease in your share price.
Other types of stocks?
You can also gamble on share prices using things such as options, which are explain here. However, these are too advanced and risky for us, so we’ll be avoiding them. Overall then, investing in stocks takes the risk and reward even higher than ETFs, mutual funds, and bonds.
You should do a huge amount of research before buying stocks, it is the very serious end of investment.
Commodities are best understood as a resources or ‘core products’ that exist at the start of production. This means that a commodity is a standard thing, i.e. vanilla is vanilla the world over, and it is traded in massive quantities. This covers everything from pork bellies to oil to gold. They are one of the most important and active types of assets that you can invest in with trillions of dollars of commodities exchanging hands yearly.
They are attractive to intermediate and advanced investors because they enable you to essentially ‘play the future’. By using your knowledge of industries and their inputs (e.g. airlines and oil demand) you can theoretically make a killing.
This means that you have to have a fairly good handle on the ebb and flow of market demand in your chosen commodities. For most beginner investors like us, precious metals such as gold and silver offer the least risky step into the commodities world.
A note on investment TFSAs
This might all seem a bit confusing but fear not, the good folks over at Greedy Rates have but together many handy guides on how to get started in your TFSA journey. While we won’t be following these strategies exactly, they are very helpful for people who want to rely on the experience of people more invested (pun intended) in the stock market. It also helps that unlike a broker, the guides and advice are free.
There are many other types of investment assets but for the purpose of beginning we’ll leave it there. Investopedia has a beginners guide and straightforward dictionary that might be of interest.
Which TFSA Provider Do I Pick?
This brings us on to a tricky subject, choosing a provider for our accounts. You can find reviews for savings type accounts aboce and investment type accounts below. We’re just going to list a couple of providers that we considered before making our choice. We recommend that you do your own due diligence first and pick a provider that’s suitable for you.
For Savings TFSAs check out up to date reviews here.
If you’re interested in ‘Roboadvisors’ ,check out the thorough reviews that Dale Roberts has done over on the Cut The Crap Investing blog.
For the purpose of our journey we’re going to go with Questrade, an online platform with shockingly reasonable fees and a whole selection of different investment assets to chose from. They actually have no purchase fees for ETFs which is great because we’ll probably buy quite a few on them over the next year!
Overall we picked Questrade instead of other providers because it is relatively straightforward to use, it is online, and it has low fees. We can be as hands on or as hands off as we want without sacrificing out earning potential through brokerage fees or low interest rates.
Before you decide on what TFSA provider to pick is is important to understand your risk profile. Have a clear idea of what you can mentally deal with long term is vitally important. Once you understand that you can chose a provider.
Whatever you choose make sure you’re ok with seeing your investments out over a period of time that best suits them. For example, stocks such as Microsoft are generally best held for periods of time to earn dividend income, not just flip for a 10% gain (although you can totally do that too).
For the BearMoney TFSA though, we’re thinking in terms of years, not months, and our journey and strategy with reflect this.
The BearMoney TFSA is a brand new account opened with Questrade to the tune of $12,000. This money will be fully invested by the end of 2020. From January 2021 onward we will be investing the maximum $500 per month in a variety of different ways. The idea is to have both a ‘starting out’ and a basic follow along investment journey with our TFSA. To this end we will keep tallies of both the starting amount ‘TFSA A’ and the monthly $500 investments ‘TFSA B’, although both will be held in the same account.
The journey will continue until at least January 2022 and hopefully beyond then. We will do our best to be as open an honest with our strategies and share insights from time to time when things go bad as well as when things go well.
That being said we need a few ground rules:
- No withdrawing TFSA money
- No multiple accounts/providers unless a wholesale switch is needed
- $12,000 in for Q4 2020
- $500 a month for 2021
- March Madness money is ‘free money’ to be used in any way within the TFSA.
Exception: March Madness.
While your personal finances are very important and you should never treat them lightly, it has always been a hallmark of BearMoney to build a little bit of waste into our financial planning. This normally means accounting for chicken wings and beers during sports games but for this investment journey something entirely different is needed.
For March 2021 we are going to dump the entire monthly TFSA contribution into penny stocks. Yes, that’s right, we’re going to essentially gamble with the entire months contribution to see just how well we can spin the roulette wheel.
What are Penny Stocks?
A penny stock is a security that trades for a very low price, with the US standard being below $5 in value. They are usually although not exclusively, shares in smaller companies. They are the highest level of risk for ‘regular stocks’ because they generally are linked to companies with limited track records of growth and profitability.
Despite this, because of their small size, small movements in share price can have significant effects on the value of your overall investment. That means that, in theory, you can turn $100 of penny stocks into $500 of penny stocks with just a $4 increase in valuation. It also means of course that you can turn $100 of penny stocks into $1 of penny stocks just as easily.
The idea of doing a ‘March Madness’ type of monthly investment into our TFSA has two primary goals.
Firstly, it’s to add an extra layer of activity to the overall investment journey, to see new ways to research and pick stocks, and to hopefully provide valuable lessons for others thinking of doing the same thing.
Secondly, it is to keep in line with the BearMoney mantra that you should always account 10% for waste. If we’re going to be investing and writing about it then we should at least add a minimum of risk and a little excitement from time to time. Otherwise we’d just have a single ETF and sit here for the next year twiddling or thumbs.
So there you have it, an outline of what a TFSA is and what we’re going to try to achieve with it over the next 12/18 months. Hopefully you’ve gotten some interesting information from this article and are as excited as we are to start this journey.
As always, if you’re going to spend your money on anything, including a TFSA, we recommend that you take professional advice and that you don’t just listen to what we have to say.
Happy Saving and we’ll see you at the end of October for Month Zero