TFSA and Risk Management
So, I took a small chunk of money the other day and transferred it into a TFSA in an account which should do some investing for me. At the outset there was a questionnaire which tried to determine how I should invest the money.
Aside from the time frame, everything I answered should have resulted in a more aggressive fund. In the end, it assigned me to a super conservative fund. So, I attempted to change that. And then I got an email advising me against it.
What am I missing?
You see, from my perspective, monies from a TFSA should generally favor the most aggressive investment strategies.
Here is why:
The limited investment headroom means that you can't really put huge sums of money into a TFSA directly to begin with. Which automatically stops you from doing something abundantly stupid. Yes, people still CAN be stupid. But, it is important that there is a hard wall and that it is a considerably low compared to what would be required for retirement.
Granted, a TFSA isn't explicitly about retirement. But, in a way it is. If you can afford to save, you should probably have an RRSP already (or your countries equivalent).
So, let's dig into the next point. Your only benefits from a TFSA is the tax sheltering on gains and ability to withdraw as you please. Period. You don't get RRSP like deductions the your income was taxed before you put it in there.
So, given the limitations on contributions and the benefits... the obvious use for a TFSA is aggressive fund investment.
Sure you can make less aggressive investments. But, they will come with much more modest gains. And more modest gains will be less of a tax burden as well. But, if you're seeking to profit here, that means you're already accepting some risk most likely. And probably also paying management fees etc...
If there were no caps on a TFSA you could just build a diversified portfolio with all of your excess investment funds. And then, a mix of lower risk options makes sense to keep in the mix.
But, there are caps. And they are low. I don't think short of a lottery win that I'll ever be able to max out my RRSP. But, despite being years behind, I think it entirely possible to max out my TFSA.
Since I was alive and eligible when TFSAs were introduced, my cap is the highest cap anyone would have. A little south of $70k. A conservative portfolio will generate about 2-4% annually. So, ... let's say $1400-2800/year. Or $100-200/mo. After tax it isn't all that big of a gain or a loss. Even less if you can't max it out.
A bit more risk might see those numbers double. But, still, we're not talking about huge gains or losses. Especially when you think of it in terms of the max annual contribution which is just 6k this year.
If you're serious about investing, you'll hit your cap. Period.
On the flip side, a higher risk investment can net 10-15% annually. Yes, they are more prone to losses. But, a TFSA and a normal account treat you the same with regards to losses, and riskier portfolios tend to lose money in the same time frames as more conservative ones. They just tend to lose less. In short, when you're going to lose money, you're going to lose money. What matters is what happens when you gain money.
The more aggressive funds will generally rebound. It may take time to recoup losses. But over the longer term they will generally deliver far better returns. So, look to that 10-15% scenario. On $70k we're now talking $7-10k/yr and over $500/mo. That is enough to take notice of when it happens. The gains and tax losses are both substantial.
And the effects are more pronounced over time. In short, gains don't count towards your contribution, so, a person who started with a more aggressive portfolio maxed out from the beginning could potentially have well north of $100k in their TFSA, whereas a conservative investor doing the same might be lucky to have breached $80k over the same period.
Using a TFSA for short term, low risk investments doesn't really make sense. The primary benefits are tax sheltering on gains and an ability to withdraw without penalty. But, the ability to withdrawal without penalty also applies to a wide array of financial offerings. Making the tax sheltering the sole benefit for consideration. And tax sheltering will always be of greatest benefits when there is a chance of a substantial gains.
If I were to give advice it would be this. Save your TFSA contribution space for funds you're willing to put into higher risk allocations. Whether your goals are short or long term. If your goals are short term, know the risks. Don't put in money you can't afford to lose. Especially if you can't afford to lose it in the short term.
If you wish for lower risk investments, use an RRSP or more traditional investment options. Only use a TFSA for low risk investment if you know you'll never be comfortable with higher risk investment.
Aside from the time frame, everything I answered should have resulted in a more aggressive fund. In the end, it assigned me to a super conservative fund. So, I attempted to change that. And then I got an email advising me against it.
What am I missing?
You see, from my perspective, monies from a TFSA should generally favor the most aggressive investment strategies.
Here is why:
- Limited investment head room.
- Tax sheltering on gains only.
The limited investment headroom means that you can't really put huge sums of money into a TFSA directly to begin with. Which automatically stops you from doing something abundantly stupid. Yes, people still CAN be stupid. But, it is important that there is a hard wall and that it is a considerably low compared to what would be required for retirement.
Granted, a TFSA isn't explicitly about retirement. But, in a way it is. If you can afford to save, you should probably have an RRSP already (or your countries equivalent).
So, let's dig into the next point. Your only benefits from a TFSA is the tax sheltering on gains and ability to withdraw as you please. Period. You don't get RRSP like deductions the your income was taxed before you put it in there.
So, given the limitations on contributions and the benefits... the obvious use for a TFSA is aggressive fund investment.
Sure you can make less aggressive investments. But, they will come with much more modest gains. And more modest gains will be less of a tax burden as well. But, if you're seeking to profit here, that means you're already accepting some risk most likely. And probably also paying management fees etc...
If there were no caps on a TFSA you could just build a diversified portfolio with all of your excess investment funds. And then, a mix of lower risk options makes sense to keep in the mix.
But, there are caps. And they are low. I don't think short of a lottery win that I'll ever be able to max out my RRSP. But, despite being years behind, I think it entirely possible to max out my TFSA.
Since I was alive and eligible when TFSAs were introduced, my cap is the highest cap anyone would have. A little south of $70k. A conservative portfolio will generate about 2-4% annually. So, ... let's say $1400-2800/year. Or $100-200/mo. After tax it isn't all that big of a gain or a loss. Even less if you can't max it out.
A bit more risk might see those numbers double. But, still, we're not talking about huge gains or losses. Especially when you think of it in terms of the max annual contribution which is just 6k this year.
If you're serious about investing, you'll hit your cap. Period.
On the flip side, a higher risk investment can net 10-15% annually. Yes, they are more prone to losses. But, a TFSA and a normal account treat you the same with regards to losses, and riskier portfolios tend to lose money in the same time frames as more conservative ones. They just tend to lose less. In short, when you're going to lose money, you're going to lose money. What matters is what happens when you gain money.
The more aggressive funds will generally rebound. It may take time to recoup losses. But over the longer term they will generally deliver far better returns. So, look to that 10-15% scenario. On $70k we're now talking $7-10k/yr and over $500/mo. That is enough to take notice of when it happens. The gains and tax losses are both substantial.
And the effects are more pronounced over time. In short, gains don't count towards your contribution, so, a person who started with a more aggressive portfolio maxed out from the beginning could potentially have well north of $100k in their TFSA, whereas a conservative investor doing the same might be lucky to have breached $80k over the same period.
Using a TFSA for short term, low risk investments doesn't really make sense. The primary benefits are tax sheltering on gains and an ability to withdraw without penalty. But, the ability to withdrawal without penalty also applies to a wide array of financial offerings. Making the tax sheltering the sole benefit for consideration. And tax sheltering will always be of greatest benefits when there is a chance of a substantial gains.
If I were to give advice it would be this. Save your TFSA contribution space for funds you're willing to put into higher risk allocations. Whether your goals are short or long term. If your goals are short term, know the risks. Don't put in money you can't afford to lose. Especially if you can't afford to lose it in the short term.
If you wish for lower risk investments, use an RRSP or more traditional investment options. Only use a TFSA for low risk investment if you know you'll never be comfortable with higher risk investment.
Comments
Post a Comment