I mentioned in a previous article that I think most people need a $5000 (or more) cash emergency fund. If someone has no other savings, they may as well keep that $5000 in a TFSA daily interest savings account. Once they have more money saved than they can contribute to their Tax Free Savings Account, they should consider keeping the emergency fund cash in a regular daily interest savings account and use the TFSA room to invest for longer term goals. Here are a few options for how someone might want to start investing using their TFSA.
When Will I Recommend My Teens Use Their TFSA Room to Invest?
My children are not eligible for TFSAs yet. You have to be 18 (19 in at least one province) to have any TFSA contribution room.
When my eldest child turns 18, I’ll suggest that first they put the maximum contribution amount for their first year into their TFSA in a daily interest savings account. Right now, that maximum contribution is $5500 per year although it might be slightly higher due to inflation when they turn 18.
The second year, though, I’ll be recommending something else. I’ll be recommending that they invest some of their money in their TFSA.
Using a TFSA to Invest for “The Future”
I think that everyone needs to save for their future. As someone who is closer to retirement than to starting out, I am very, very, very glad I started saving for my retirement as soon as I graduated from university. Those savings have really grown since.
Now many people will balk at saving for retirement in their 20s (or teens!). Fine. It doesn’t *have* to be for retirement. Consider it as saving vaguely “for the future.” Maybe it will be for a wedding, an unexpected very important choice, a home, or early retirement at, say, 40. Any of those things will be easier with savings. So don’t get too worried about labeling exactly for what the money is to be used. Just save it!
I read The Wealthy Barber before the year 2000, and I agree with one of its suggestions: you need to save by “paying yourself first.” You need to save 10-20% of every dollar you bring home from work and do it so automatically it’s as if you never got paid that money.
If at all possible (and it is not always possible) you need to cut your expenses enough that you can save your chosen 10-20%. You may need to choose a cheaper apartment, or even need to share a room in a one-bedroom apartment. If that sounds horrible, do whatever you legally and pleasantly can to earn a higher income so that the 80-90% of your income you have to spend will allow you to rent a better place.
Save that 10-20% in your TFSA. And invest it for the longer-term future.
Using a TFSA to Invest for Life’s Luxuries
In my teen child’s second year, at age 19, I’ll be recommending they think about their savings and their salary in two ways: There is money needed to pay the bills and there is money for the luxury of extra things. For example, if you have $10 000 a year, you may need $9500 of that for bills and you may save $500 of that for a vacation. If the $9500 is money that is needed to survive, you shouldn’t risk any of it. Save it in a daily interest savings account or cashable GICs or something similar.
But the $500 is different. It’s great to have a vacation or buy a cool electronic device. It’s also not the end of (your) world if you can’t. So the money you can invest and take a bit of risk with is your “luxury” money.
If you are willing to risk losing your luxury money in order to watch it grow more quickly, if you’re lucky and the fates allow, then you can invest your luxury money inside your TFSA too.
In the Beginning, How Should I Invest in my Tax Free Savings Account?
Ok, so now my teen has 10% of their income and a bit of savings dedicated to “luxury” purchases that they’d like to invest in a TFSA. What can they do?
(I’m assuming that the combination of the two is less than their available TFSA contribution room. If they get $5500 of room a year, they likely can invest all of their future and luxury savings within their TFSA.)
My Teenager Hates Handling Finances and Making Decisions
One of my children looks like they will be the type of person who hates managing money and fiddling with banking issues.
I’d suggest that child invest their long term and luxury savings in a TFSA at Tangerine. I’d suggest they buy units in the Tangerine Balanced Fund that best suits those long term goals (and their risk tolerance.)
- The Tangerine Balanced Funds offer a “couch potato” style of investing. Because there is no fee to buy new units in the fund. So each pay cheque they can contribute a small amount to their TFSA and buy units.
- Because Tangerine will “re-balance” their savings to keep it split appropriately. If my teen bought units in 3 separate funds, for instance the very low fee e-funds from TD, they would have to keep track of the value of their total investments in each of the 3 funds. Once a year, they would have to either aggressively buy more units in whichever funds were less than their target percentage, or would have to sell some units of whichever fund they had too much invested in so that they could buy units in the other two funds. It requires more patience and a tiny bit more work. Paying Tangerine a higher fee means you don’t have to do this.
What Does a Tangerine Balanced Fund or Couch Potato Fund Mean?
When you invest, you need to decide what your preferred asset allocation looks like.
- 25% Canadian stock market index-mirroring equities
- 25% USA market
- 25% world markets
- and 25% bonds.
With Tangerine, and some other places, you pick the Fund that holds its investments in those percentages and you buy units of that one Fund.
You then just wait and watch the fund value go up and down over time.
In theory over a long period of time, like 10 years, you should see that your investments have grown about 7% a year. (It may grow 2%, 59%, 1% and 25% in some years and shrink 2%, 15%, 1% and 22% other years. What matters is whether after 10 years you have almost twice as much money as you started with, not what the value is at the end of each day or year.)
Buying units in a fund like this intended to:
- Avoid having to guess which stocks will earn you the most money over time
- Keep you well diversified by buying essentially small amounts of all of the stocks listed on the world’s major stock exchanges
- Avoid having to guess in which part of the world stock values will go up the most
- Encourage you NOT to panic and sell your holdings just because they drop in value, even if they drop 50% in value; you have to leave them alone and give them time to “re-bound” or return to their previous value
What If I Don’t Want to Invest In the Tangerine Balanced Funds in my TFSA?
Fair enough. Lots of people don’t.
One even lower-cost (but slightly more work) alternative is to open a self-directed online investing account with TD. You can read about investing in TD e-funds, which have very low fees, at the Canadian Couch Potato website.
Another way to keep costs low is to buy units of ETFs instead of mutual funds. Most banks and brokerages charge you for each ETF purchase and sale, however, which may mean you have to save up and invest only once or twice a year. Some brokerages, like Scotia iTrade, allow you to purchase some but not all ETFs for no fee. You’d have to check if you like what they offer. Another discount brokerage, Questrade, lets you buy ETFs for no fee, but there have been some issues in the past with their customer service that leaves me unwilling to recommend using their brokerage.
You can buy mutual funds from almost any bank or credit union. Be very, very, very careful of the fees though. I have yet to read any where of any of them that charge lower or equivalent fees to Tangerine or to the TD e-funds. Personally, I don’t recommend bank mutual funds to anyone.
You can invest in individual stocks. That’s another option that is worth seriously considering for a certain type of investor. I’ll write about it in another article.
Do you think everyone should try to save 10-20% of their take home pay for the future and for luxuries? Please share your views with a comment.