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I’m often asked by money-management novices about what it takes to start investing. Most are uncertain about their money skills, and many wonder if it just isn’t “safer” to leave their money in a bank savings account and hope for the best. My answer often surprises them: Anyone can be an investor – and you don’t need a degree in higher finance to do it successfully.
Even if you’re an absolute novice with no knowledge of investments or markets or economics, you can start investing today. And you don’t need a small fortune to do it. You don’t need even need a stockbroker or an online trading account of any kind. All you need to do is pay a visit to your local bank branch or website. And then open a Tax-Free Savings Account (TFSA).
A TFSA is a type of savings account registered with the federal government, much like a Registered Retirement Savings Plan. But the rules for a TFSA are much simpler, and there is one distinct advantage over an RRSP: investments in an RRSP grow on a tax-free basis until withdrawn; but investments in a TFSA do not attract tax ever – withdrawals from the plan are tax-free.
This makes a big difference if you’re using a TFSA as an investment vehicle to generate growth to meet a mid-term savings goal, say over a 10-year period. Here’s where we get to the “investment” part of your new financial life.
A Tax-Free Savings Account can hold a wide variety of investments, much like an RRSP. These include:
As with RRSPs, however, you lose the benefits of the dividend tax credit, the capital gains exemption, and the use of capital losses within the TFSA. For novice investors looking for a non-complicated way to generate growth over a period of a few years, this usually won’t be an issue.
Here’s why. One of the easiest ways to become an investor is to invest in units of a mutual fund or exchange-traded fund. Basically, the fund invests your money in a portfolio of securities along with other investors in the fund. You don’t own the securities directly; instead, you own units of the fund, the value of which is based on the securities in its portfolio. The advantage here is that you are in essence buying professional management of your investment at a cost much less than you’d pay if you hired your own private managers. And some of these managers are very good indeed.
A search of The Fund Library database yielded a list of the top-performing funds over the past 10 years that have a Fundata A-Grade rating. As an example, I looked at the RBC U.S. Mid-Cap Growth Equity Fund Series D, which produced a 10-year average annual compounded rate of return of 13.6% to March 31, 2023. A $10,000 investment in this fund 10 years ago would have grown to nearly $36,000 today. (In a TFSA, that would be completely tax-free.) It’s a no-load fund too, meaning there are no sales commissions, and its management expense ratio is a relatively low 1.21%. And you don’t have to be Warren Buffett to start investing: minimum initial investment is $25.
This is not a recommendation to buy this fund particularly. But it is an illustration of the kinds of funds and returns that are available for the novice investor. Want to multiply that growth? Contribute more and let the magic of compounding do its work.
The annual contribution limit for Tax-Free Savings Accounts (TFSA) has risen to $6,500 in 2023, and it is not income-dependent or limited by contributions to other plans like RRSPs or RPPs. Unused contributions can be carried forward to future years, bringing total contribution room available since the introduction of the plan in 2009 to $88,00 for someone who has never contributed to a TFSA.
There’s no deadline date for contributions for the year, because there is no tax deduction available for contributions as there is for RRSPs. You can contribute any amount at any time you want through the year, as long as you don’t exceed your maximum. You have to be over 18 and a have a valid Canadian Social Insurance Number.
Want to retire with a million? A TFSA can actually do it. Let’s say you are 30 years old today, you make $60,000 a year, and you are able to contribute $31,000 to your TFSA right away. If you then continue to contribute $6,000 every year until you retire at age 65 (that’s $500 per month), at an average compounded annual rate of return of 8%, your TFSA would grow to $1,536,522, and all of it tax-free.
Don’t make the mistake of using your TFSA as your personal ATM. If you frequently dip into it when you’re short of funds, and then top up again when you’re flush without keeping an eagle eye on your transaction, you could end up with “excess amounts” in your TFSA – that is, over and above the $6,000 annual contribution limit for the year.
That’s when a tax penalty of 1% per month kicks in. It’s based on the highest excess TFSA amount in your account for each month in which an excess exists. This means that the 1% tax applies for a particular month even if an excess amount was contributed and withdrawn later during the same month. The excess-amount tax kicks in on the first dollar of excess contributions.
Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management and an independent financial planning consultant.
Notes and Disclaimer
Content copyright © 2023 by Robyn K. Thompson. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.
The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.
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