Tax-Free Savings Account | Financial Crooks

I mentioned earlier that I’ll be suggesting my young teen relative open a TFSA as soon as he is 18. I’d suggest he save his first $5500 in cash in a cashable GIC or a high interest savings account as an emergency fund. Once he has more than $5500 in savings, though, I’d suggest he keep his cash outside his TFSA and use the room to shelter income earned from higher yielding investments. He would likely do best if he invested his “equity” high-risk long-term savings in mutual funds or ETFs that mirror the major stock indices (the TSX for Canada; the NYSE for the US; various others for the world). That’s why I suggested he consider investing in Tangerine Balanced funds. Some people, however, don’t like buying index funds. They may prefer another investing approach and buy individual stocks in their TFSA instead.

When Is It Worthwhile to Open a Self-Directed TFSA at a Brokerage?

You can’t buy stocks within a TFSA without having a brokerage account.

If you don’t want the shares in a “registered” account, you can just buy them without a brokerage. For example, you can buy shares in Suncor from someone who owns some and then buy more after registering those shares with the correct Transfer Agent, Computershare. You’ll get your dividends direct deposited into your bank account or by cheque. But Computershare does not manage “registered” accounts like TFSAs and RRSPs. So you can’t use this approach for a TFSA. Or at least I couldn’t find any way to do it.

All of the big Canadian banks offer a discount brokerage that will let you open a self-directed TFSA account. There are also several independent discount brokerages. Fees change all the time but many of these brokerages will charge a fee if you don’t have at least $10 000 in assets in your TFSA. So check the details carefully before opening a TFSA brokerage account. What minimum balance is required to avoid annual, quarterly, or inactivity fees? What will it cost to purchase (or sell) shares?

Are There Any Benefits for a Teen to Opening a TFSA at Their Parent’s Brokerage?

Some discount brokerages waive the minimum balance requirement for accounts held by family members living at the same address. Check the details of your own brokerage if your teen is ready to open a self-directed TFSA.

How Would I Suggest a Teen Use a Self-Directed Brokerage TFSA to Buy Shares of Stocks?

As I said earlier, I would recommend a teen get a stock-market-mirroring ETF or mutual fund before recommending individual stocks.

If individual stocks are what they want, however, that’s their choice.

I think they should only be investing their long-term savings in equities of any kind. I also believe that those savings should be only 10-25% of their total savings until they have about $50 000 in cash and fixed income.

Those things said, they may only have $5000 to invest in stocks in their TFSA.

Should they use all $5 000 to buy shares in one company, or buy $1 000 of each of 5 companies?

I’d say that if you have invested in only 1 or 5 companies you are not diversified. You might as well take all of the risk and bet all of your money on one horse. So I’d invest the $5 000 in one company. Then, when I have saved up another $5 000, I’d buy shares in my next choice.

What Stocks Would be Good for a Beginning Investor?

Any stock can down now. Most stocks will go way down just when you least expect it. There is no stock that is best for a beginning or experienced investor.

Generally, though, if you are going to pick individual stocks, which is very risky and has been more or less proven to earn you a lower return over the long run, you probably should start with the kind that pays a reasonable dividend so that you have some income during the years when the stock is down in value and you don’t want to sell it because you would guarantee you lose money by doing that.

So look at the current situation of some of the big names and talk to financial experts to understand how to evaluate the performance and expected performance of those stocks.

Common choices include

BCE
Any of the big 5 Canadian banks, such as BMO, BNS, CM, RY, TD
FTS, ENB, TRP
CNR

Any of these stocks could crash at any time. There are times when it is better to buy each of these types of stocks depending on their current price and their expected performance.

Should I Pick Exciting Growth Stocks for My TFSA?

You can pick anything you want. If you see an electric car startup that you’re sure will triple in value in a year, yes, you can buy its stock if it’s listed on the TSX.

But ask yourself why you are willing to take this risk. Would you pull out all of your savings and use them to gamble at a casino? If not, why would you gamble this way?

If your stock drops in value or the company goes bankrupt you can NOT claim a capital loss in your TFSA. Nor do you ever get back your contribution room. You’ve wasted your TFSA contribution space and you’ve lost money that cannot be used to offset gains from other more successful investments. A lose-lose scenario. Not what I’d choose.

Good Luck Picking Individual Stocks for Your TFSA

Overall, picking individual stocks for your TFSA is a tiring, somewhat worrying approach. If you don’t really like managing money or handling investments, why not just stick to the Canadian Couch Potato approach and buy ETFs or mutual funds? It will likely make you more money and take less thought and worry.

Either way, I’d encourage people saving for the long-term to use their TFSA to buy and hold equity investments.

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Do you use your TFSA only for cash and fixed income investments or do you have equities in it? Please share your strategy with a comment.

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.)

Why?

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.

Maybe it’s

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.