Most Canadians who own a Tax-Free Savings Account (TFSA) are well-aware that the account shelters their investments from taxes.
Nevertheless, a majority of people who own a TFSA aren’t entirely familiar with the versatility of this excellent investing tool. TFSAs have extended benefits that can help you avoid paying taxes on the interest that you earn, keeping more of your money right where it belongs.
Choosing the right TFSA, depending on your risk tolerance profile, can see your wealth growing and you avoiding unforeseeable disappointment.
What is TFSA?
A Tax-Free Savings Account (TFSA) is less of a savings account and more like an investment tool. Using a TFSA allows wealth to grow without taxation on interest.
Though many tend to use it as a regular savings account, a TFSA holds several types of investments and securities. Some of these include the guaranteed investment certificate (GIC), stocks, exchange-traded funds (ETFs), mutual funds, and cash savings, among other options. A robo-advisor or financial advisor can also manage a TFSA.
Unlike high-interest savings accounts (HISAs), a TFSA has a yearly contribution limit. The limit increases each year and allows unlimited withdrawals and contributions at no cost or penalty. Contributing over your annual limit comes with a monetary penalty.
Any Canadian resident over the age of 18 can open a TFSA. The account is available with most credit unions and banks.
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What is Risk Tolerance in Investing?
Risk tolerance is an investor’s threshold for dealing with variability and the potential loss of investments.
Risk tolerance also determines what kind of investments they will purchase, based on the level of risk they’re willing to experience.
An investor’s risk tolerance depends profoundly on their capability to withstand loss, especially if the investment fluctuates frequently.
Purchasing investments that do not align with an investors risk tolerance profile can cause problems and stress in the long run, in the event that the investment experiences a sharp loss. Pulling the investment at a loss can also have investors pulling out too early and missing out on potential gains.
Risk tolerance is shaped dramatically by the investor’s income, financial goals, personal wealth, and age.
Different Levels of Risk Tolerance
There are three levels of risk tolerance: low, medium, and high, or, conservative, moderate, and aggressive.
Conservative or low-risk investing is investing that pose little risk and smaller returns. Generally, these investments are in GICs or bonds.
Moderate investing, also known as medium risk or balanced investing poses medium risk. Moderate-risk Investments usually involve Canadian, US, and foreign stocks. Some options include mutual funds as well.
Aggressive investing or high-risk investing sees investments in balanced markets or stocks.
What is Risk Capacity?
Risk Capacity, also known as Risk Appetite, is an investor’s attitude to approaching risk. Personal financial goals shape an investor’s Risk Capacity and eventually, their Risk Tolerance.
There are five different character types of Risk Capacity: Averse (no risk), Minimalist (minimal risk), Cautious (lower-risk), Open (medium-risk), and Hungry (high-risk).
Why Should I Use a TFSA to Invest?
Tax-Free Savings Accounts serve as an excellent vehicle to avoid paying taxes on the interest that your savings or investments earn on returns, but that’s not the only reason to use them.
TFSA investment options come with enough flexibility. Investments that can in a TFSA are called qualified investments.
Some qualified investments are Guaranteed Investment Certificates (GICs), High-Interest Savings Accounts (HISAs), stocks, mutual funds, bonds, and cash.
What Investments Can I Hold in a TFSA account?
You can hold several investments in a TFSA that suit your risk tolerance. Below are some of the options that are currently available to Canadians.
Guaranteed Investment Certificate (GICs)
Guaranteed Investment Certificates (GICs) are an incredibly low-risk investment and a great way to utilize a TFSA. Since GICs are taxed, using a TFSA GIC is a move that most investors can take advantage of if they’re planning on purchasing GICs. Though returns on GICs tend to be lower, they are safe, insured, and guaranteed.
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Stocks, Bonds, and Exchange-traded Funds (ETFs)
Stocks, bonds, and Exchange-traded Transfers (ETFs) all pose different levels of risk from one another and within themselves.
Stocks pose high-risk due to the volatility of the stock market, as many of the events that can affect it are unpredictable. The returns are usually much higher, depending on the amount and duration invested. Stocks are also susceptible to tax, so using a TFSA to hold shares can save you a hefty chunk of change.
Bonds are lower-risk investments but depend on the strength of the economy. They are not insured but hold steadier risk profiles and lower returns.
Exchange-traded Funds (ETFs) combine various stocks, bonds, and investments to create a portfolio for you. You can purchase them through a robo-advisor, which will manage your funds for you based on the risk profile of your choosing.
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Cash (TFSA Savings Account)
Using a TFSA savings account is a low-risk option of investing. Banks in Canada are usually insured by the Canada Deposit Insurance Corporation (CDIC) at no additional cost. Return rates are generally lower but hold no risk.
|Compare the Best TFSAs in Canada||Compare TFSAs|
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