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Best TFSA Investment Options

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A tax-free savings account (TFSA) is a powerful tool that can help Canadians invest and save money for the future. Even though the term “savings account” is in its name, a TFSA can be used to invest in a wide variety of investment options, such as stocks, bonds, GICs, ETFs, and mutual funds. The money you make from your TFSA is tax-free, whether from capital gains, interest, or dividends. With so many options to choose from, what should you invest in? This page will take a look at the best TFSA investment options in Canada, the risks that come with each choice, and what to consider when choosing investments for your TFSA.

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Types of TFSA Investments

TFSA Savings Accounts

Risk: None

Return: Low

A high-interest savings account (HISA) or savings account can be registered as a TFSA to allow the interest income to be tax-free. Savings accounts are virtually risk-free, as the only way to lose money is if your bank or credit union fails and cannot return your funds. Even then, your deposits are protected by free deposit insurance offered by the government, such as CDIC deposit insurance for deposits at Canadian banks or provincial deposit insurance programs at credit unions, up to certain limits.

This means that putting your money into a savings account has no risk, but in return, the money that you can make from a savings account is fairly small. Interest rates for savings accounts are low, often below the rate of inflation, which means that you’ll be losing purchasing power. In other words, the money you put into a savings account will slowly lose value over time.

For those with a long-term investment horizon, such as those who are young and saving up for retirement, there may be better options than a savings account. However, those with a low-risk tolerance, such as those nearing retirement or needing to use the money soon, might benefit from a savings account. These accounts are safe and offer consistently low, but reliable returns. A small amount of interest income is better than keeping the money as cash and earning nothing. On the other hand, your TFSA contribution room might be better used towards investments that have the possibility of larger gains, and so larger tax-savings.

TFSA GICs

Risk: None

Return: Low

Similar to a high-interest TFSA, a guaranteed investment certificate (GIC) is a risk-free way to invest your money. With a GIC, you’ll be depositing your money for a certain period of time, called the term. The bank will pay you a guaranteed interest rate, or rate of return, over that term. This rate is usually higher than what you would earn in a savings account. In exchange, you can’t withdraw your money from most GICs without penalties, which is the case with non-redeemable GICs. The most common term length for a GIC is from 1 year to 5 years.

Redeemable and cashable GICs allow you to withdraw your money and keep some or all of the interest earned. They have a lower interest rate than non-redeemable GICs, but they can still offer a decent return. Also similar to savings accounts, GICs are insured by the CDIC or equivalent provincial insurance program. This means that even if your bank or credit union goes bankrupt, you’ll get some or all of your money back, depending on the insurer’s limit and how much you invested in GICs.

TFSA GICs can be a good choice for those that don’t want to risk their money, but want to earn a slightly better rate than a savings account. You’ll need to make sure that you won’t need to access your money for the term that you choose, or you might be giving up some or all of the interest earned. On the other hand, GICs and their terms give you a predictable schedule of returns, making them a reliable option. If you need the money in 5 years, you could invest in a 5-year TFSA GIC, and you’ll know how much money you’ll get back at the end of those 5 years.

Some special types of GICs, such as market-linked GICs and variable-rate GICs, might offer better or worse returns than normal GICs. These GIC variations offer more risk but with the possibility for higher returns. For investors that want to make sure that their principal is protected but have exposure to the stock market, a market-linked GIC follows the return of a specific index, such as a stock market index, up to a certain maximum return over the term. It may also offer a minimum guaranteed return. Variable-rate GICs are usually based on the prime rate. When the prime rate increases, a variable-rate GIC will increase its interest rate too. The opposite can happen as well.

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For those that are more financially savvy and want to take a more active role in their investments, a self-directed TFSA allows you to customize your portfolio with stocks, bonds, mutual funds, and other securities. Self-directed TFSAs are accounts opened at a brokerage, such as online trading platforms or bank brokerages. With them, you’ll open up a wide variety of markets for you to choose from for your TFSA.

Buying Stocks with a TFSAs

Risk: High

Return: High

From penny stocks to dividend paying blue chip stocks, stocks can range from low-risk to high-risk. Buying penny stocks in a TFSA is allowed, but there’s the risk that you could lose considerable amounts of money. Since the gains made in a TFSA are tax-free, buying stocks in a TFSA is a popular option for self-directed accounts and it’s a good way to save up for retirement, provided that you have a long enough investing horizon. This makes stocks not a good option for those that don’t want the volatility that comes with the stock market.

There’s no limit to the number of stocks that you can buy or the number of shares that you can hold in a TFSA. However, you are limited to stocks that are traded on what the government considers as a “designated stock exchange”. This includes popular stock exchanges such as the Toronto Stock Exchange (TSX), the New York Stock Exchange (NYSE), and the Nasdaq.

Note: TFSAs are meant for investing and saving. This means that you are not allowed to trade stocks using your TFSA. Day trading, or frequently buying and selling the same stocks in a short period of time, could be considered to be running a business. This may result in the CRA requiring you to pay tax on your TFSA investment earnings.

Buying ETFs with a TFSA

Risk: Varies

Return: Varies

An exchange-traded fund (ETF) tracks an index, such as the Toronto Stock Exchange (S&P/TSX 60) or the S&P 500, and trades just like a stock. ETFs can offer investors exposure to a wide range of assets, including stocks, bonds, commodities and cryptocurrencies, and can have special features such as leverage or inverse exposure.

Instead of buying multiple stocks to diversify your portfolio, a single ETF can give you exposure to any number of underlying assets. For example, the iShares Core MSCI Total International Stock ETF (NASDAQ: IXUS) holds over 4,300 stocks from companies around the world. This makes ETFs a great way to diversify your portfolio without having to purchase multiple individual stocks or bonds.

Some ETFs are more targeted, such as the sector-specific BMO Equal Weight Banks Index ETF (ZEB), which tracks Canada’s Big 6 Banks stocks. Or, they might focus on a specific commodity or asset, such as the iShares Gold Bullion ETF or the Purpose Bitcoin ETF. There are also inverse ETFs that give you the inverse return of the underlying index, which allows you to indirectly short stocks or an index.

While mutual funds can also give you exposure to a wide variety of stocks and diversify your portfolio, they often have higher fees than ETFs. Additionally, the buying and selling of mutual funds is limited to certain times of day. ETFs can be bought and sold like stocks, giving you more flexibility.

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Bonds with a TFSA

Risk: Low-Medium

Return: Low-Medium

Bonds are a type of fixed-income security since you'll receive interest at regular intervals over the life of the bond. Depending on the type of bond that you buy, bonds can be a safer choice than stocks. For example, you can buy government bonds, which may include municipal bonds, provincial bonds, or federal bonds. Government of Canada bonds are considered to be very safe investments, but their return is lower as a result.

Similar to a GIC, a bond is for a specific length of time. Holding government bonds in your TFSA is a good way to preserve your capital from losses, while still earning interest income tax-free. As an alternative to holding bonds, you could purchase ETFs that track a basket of bonds. This can help diversify your portfolio while still keeping it focused on bonds. For example, the iShares Core Canadian Universe Bond Index ETF gives you exposure to a variety of Canadian bonds, and pays out monthly cash distributions.

Other types of bonds include corporate bonds, which might be investment-grade or high-yield (junk) bonds, which depends on the company’s credit rating. Corporate bonds may pay higher interest rates than government bonds, but they come with additional risk, as the company could default on its debt obligations.

Options with a TFSA

Risk: Varies

Return: Varies

You can buy and sell options in your TFSA. Some option contracts give you leverage, such as by buying a long call option, without requiring margin. For example, by buying one long call option, you can get market exposure to 100 shares of the underlying stock in exchange for paying the option premium. This might allow you to achieve higher returns than buying the stock using your TFSA, but options also carry a greater risk of loss.

Mutual Fund TFSAs

Risk: Varies

Return: Varies

Mutual funds are managed by professionals who choose the stocks and select the investment strategies to follow. They often have high management fees, which can be 2% per year or higher, and they might come with restrictions on when you can buy or sell. With a self-directed TFSA at a brokerage, you can purchase mutual funds from a variety of providers. Otherwise, you’ll generally be limited to the mutual funds that your bank offers.

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Now that we know what you can invest in using your TFSA, which options should you choose? It depends on your goals, risk tolerance and timeline. Let’s take a look at a couple scenarios to see which investment option might be best for you.

If you have a long investment horizon, such as if you’re saving up for retirement, then you’ll be able to take on more risk. That’s because short-term movements in your TFSA investment portfolio won’t affect you, as any losses in the meantime could be easily recovered from years from now. If you’re looking to save for retirement, the best long-term TFSA investments would be stocks and equity ETFs. These investments have the potential to generate higher returns over time, in exchange for higher risk.

For stocks, you might want to consider dividend paying blue-chip stocks. These are large, established companies with a track record of paying reliable dividends over the years. You can use these as part of your TFSA strategy and benefit from their long-term growth potential, while still collecting regular income in the form of dividends. Some of the best dividend stocks have annual yields well over 10%. Plus, Canadian dividends aren’t taxed in a TFSA, which means that you can withdraw the dividends tax-free or reinvest them to compound your investment returns.

For ETFs, an equity-heavy portfolio would help to maximize growth. This would generally be index ETFs, such as those that track the S&P/TSX 60 for Canadian stocks or S&P 500 for American stocks. There are also international equity ETFs and emerging markets ETFs to gain exposure outside of Canadian equities.

If you’re saving up for a rainy day, or if you need to access the money soon, short-term TFSA investments are more focused on how easily you can get the money out with as little risk and volatility as possible. For example, you might be saving up for a down payment for a house, but you don't need the money until a year from now. Instead of leaving it as cash, you could put the money into a TFSA account and invest it in a low-risk, short-term investment like government bonds or GICs.

Some short-term TFSA investment options include savings accounts, GICs, and some short-term bonds and ETFs. If you choose to invest in a GIC or bond, make sure to choose a term that is less than when you expect that you need the money. That way you aren’t locked into a lengthy term and have to pay penalties to withdraw your money. In the case of GICs, you can also choose cashable GICs which allow you to withdraw early without penalties.

For bonds, the Government of Canada offers a variety of short term lengths as well, such as 1-year Government of Canada bonds or even 1-month treasury bills. You can also invest in ETFs or mutual funds that invest in short-term bonds or cash-like securities, such as the iShares Core Canadian Short Term Bond Index ETF or the iShares Premium Money Market ETF. There are even ETFs that invest in high-interest savings accounts, like the Evolve High Interest Savings Account Fund (HISA) and Horizons High Interest Savings ETF (CASH).