What Investments Should I Have in My TFSA?

I received a great question the other day.  A friend of mine asked "I'm looking for a good investment for my TFSA that pays nice dividends, what do you suggest"?

What seems like a simple question gives us much food for thought.  Most importantly, and the real thrust of this post, is that questions like these should not be asked (or answered) in a vacuum.  You really need to take a step back and consider your overall goals, current assets, saving strategy, investment plan, and retirement strategy across all of your investment accounts.

What do I plan to use my TFSA for?

Given that you can only contribute so much into a TFSA, you may want to ask yourself what is the goal and purpose of the TFSA and how does it fit into your overall financial plan.

Some practical examples of how TFSAs can be used:

• Some people have enough money and/or pension income to draw funds needed in retirement from RRSPs, non-registered accounts, or elsewhere (see the article linked below).  These folks might plan to use TFSAs as a long term tax sheltered growth vehicle and may contain investments for the long term such as equities.

• Or a TFSA may be a necessary part of a retirement drawdown plan and the investments therein should truly be evaluated as part of a total return approach as outlined in the article linked below. Maybe some in equities, maybe some in cash, and maybe some in fixed income such as bonds.

• For others, the TFSA is a perfect place to store cash for “emergencies” such as unemployment, an unplanned house repair, or other calamity.  Or it could be for a “once in a lifetime” special trip - maybe at bargain rates. For folks in this category, mostly want to preserve their TFSA balance and access it quickly (highly liquid).  So things like high interest savings accounts, short term GICs, or a cash ETF are often the best choice here.

• The TFSA might also be a true savings account and will be used for a down payment on a house, car, or other big purchase in teh near future.  This falls roughly into the same category as emergency needs (Preserve TFSA balance, investments easy to access) and so the same investments apply.

This is where a detailed financial plan that itemizes when and how you plan to utilize your TFSA (and other investment accounts) can really help to provide the guidance necessary to meet your long term goals.

Do you plan to retire soon or are you already retired now?

If so, think about your overall retirement drawdown or "decumulation" strategy.  Working with a financial planner or even building a plan of your own will allow you to better see an overall strategy.  This should include how much you should take out to meet your spending needs and roughly from where (defined pensions, RRSPs, Non-registered accounts, TFSA, OAS, CPP, GIS, etc.).  How you draw down your assets can have a significant impact on both what you have left to live off, and also the taxes you pay over the span of retirement too. 

Know also that if you have a goal to leave a legacy or inheritance for your kids, the TFSA is the absolute best way to do so as it has great estate tax treatment.

As further guidance, the excellent article below discusses where your investments might reside especially in the context of a “total return approach”.  One point of note is for those with a defined benefit pension can often think about their pension as being the fixed income portion of their investments (i.e. their pension has the same function as bonds with even less risk).

 https://www.moneysense.ca/save/retirement/a-better-way-to-generate-retirement-income/

What mix of assets is appropriate for my risk tolerance and circumstances?

We are talking here about "asset allocation" which means how you plan to spread your investments across things like stocks, bonds, and cash/money market securities.

Your own asset allocation should include a blend of investments, from the most aggressive (most risky, most volatile) to the safest (least risky, least volatile) that will give you the total net return over time that you need to meet your goals.

The mix or percentage of your portfolio you devote to each type of asset depends on both your time frame and your personal tolerance for risk.

Plus, your asset allocation can change over time.  Maybe you are approaching retirement or maybe your needs or goals have changed.

Any investment decision, such as the decision to invest in "nice paying dividend stocks" for your TFSA, should really be aligned with your overall asset allocation strategy which, in turn, aligns with your overall goals and risk tolerance.

Should I worry about tax efficiency in my TFSA?

Just to be clear, when we are talking about tax efficiency, what we are really talking about is "asset location".  That is, which assets (such as equities, bonds, etc.) should I hold in my RRSP versus my TFSA versus non-registered (non-tax sheltered) accounts.

Conventional financial advice on this subject suggests Canadians should do the following:

1. Hold Fixed Income assets in your RRSP

2. Hold Canadian equities in your non-registered account

3. Hold International equities in your TFSA

4. Hold United States equities in your RRSP (only after fixed income)

This is due to the rate and nature of how returns from various assets are taxed in Canada.  So, according to this conventional wisdom, fixed Income like bond distributions and interest payments are taxed at the highest rate and should thus be tax sheltered.  Equities, and in particular Canadian dividend paying equities, are taxed at lower rates, and should thus better suited for non-taxable accounts. U.S. equities can also pay dividends and, unless they are in an RRSP, you have to pay additional foreign dividends taxes.

However, given that we neither know future rates of return on various asset classes nor are we certain that the taxation rules in Canada will remain constant It is hard to predict overall future outcomes.  Add to this the increased complexity of managing such a diverse portfolio, and it is a reasonable strategy to simply not worry about tax efficiency in your TFSA.

Ben Felix of PWL Capital does an excellent job explaining this on his YouTube channel linked here >> Ben Felix of PWL Capital explaining Asset Location

So, back to the original question:  "I’m looking for a good investment for my TFSA that pays nice dividends, what do you suggest"?

Hopefully, after reading this blog, you understand that there is no one good or correct answer to the question.  And, in fact, the question itself is flawed and should really be replaced by something like this:

I know my current TFSA investments don't match my overall goals and investment strategy, so what must I do to match my TFSA with my overall goals?

And to answer that question, it starts with a firm understanding of your overall goals, current assets, saving and investment plan, and retirement strategy across all your investment accounts.