2017 brought in a big milestone for the TFSA. For the first time ever the threshold for the TFSA crossed the magical $50K line. Why is that important? In general, most financial advisers and savvy investors would tell you that when you reach over $50K in assets, it’s better to go with lost cost ETFs rather than high fee mutual funds.
You’ll read this and probably wonder why you should switch to low cost ETFs when mutual funds have been doing such a great job. That’s quite easy. When the average mutual fund in Canada averages around 2.5% in fees and the low cost ETF has fees around 0.05% to 0.6% that 2% savings that you are getting is huge. To put in perspective after 1 year of owning index funds in ETFs versus mutual funds, the cost difference is staggering:
2.5% on $50k in mutual funds = $1,250
0.5% on $50 in ETFs = $250
If you have ETFs that average around 0.5% versus mutual funds that average 2.5%, the average savings per year for holding ETFs is $1,000. I’m not sure about you, but for me $1,000 in savings is quite significant. Considering both the ETFs and mutual funds are holding the same indexes, why wouldn’t you want to pay less?
Lower Trading Fees
At most major financial institutions trading fees can range from $15 to $29 dollars per transaction. When you buy mutual funds these commission fees are waived, but the corollary is that you pay higher management fees.
Now that the TFSA allows for a higher limit, most brokerages will offer discount commission fees around $5 to $10 on accounts that reach $50K or more. This means your trades are cheaper and the difference between the management fees is more than enough to offset trades that you might make while purchasing ETFs.
So unless you’re a day trader (and you shouldn’t be), the $1,000 in management fees won’t make up the cost of trading ETFs.
TFSA Is NOT For Cash
Back to the TFSA account. Most Canadians still use these accounts incorrectly. The idea behind the creation of the TFSA was for long term investment, not a cash savings account. Perhaps one of the biggest marketing flaws of all time done by the banks (or good depending on your perspective) was to portray the TFSA account as a glorified, high interest savings account to supplement your day-to-day, standard chequing account.
Accumulating interest on cash, although tax free, is not an effective use of a TFSA. Gains through long term investing would achieve much higher gains, and be tax sheltered when withdrawn in the future. This means any gains made in the TFSA never have to be reported to the government. The income also won’t count against OAS and GIS calculations for old-age benefits, if they still exist when you qualify.
Perhaps the government should have labelled these accounts as Tax Free Retirement Account but rather Tax Free Savings Account. Out of prudence by the government, these accounts were marketed in such a way to ensure that the ignorance of the general public would mean that future government tax revenues wouldn’t suffer. As opposed to RRSP withdrawals, TFSA withdrawals would be tax free forever.
Why Stay Ignorant?
So why aren’t Canadians using their TFSAs to invest? Because they don’t know any better. The government successfully brainwashed individuals to think that the TFSA was for the rich. They don’t want people to find out that the secret sauce to the TFSA account. If they did, the government would lose billions in tax revenues in the future.
The government also gave many more perks to the RRSP account, like tax returns, home buyer’s plans and school payment to ensure that when individual withdraw money they would still be paying tax. It’s like the RRSP was portrayed as the high school prom queen and the TFSA was the nerdy geek sitting in the corner. No one wants to be friends with the geek.
The fact remains that during any 15 year rolling period the stock market has never gone negative. This includes the great depression, the tech bubble in 2000 and the infamous credit crisis in 2008. Take any 15 year period. I dare you to try. Given how resilient the markets are, it makes perfect sense to invest long term in the TFSA.
If you’re a couple or married, the TFSA has even greater advantages because the sum of two accounts can equate to over $100k. That can be a serious wealth generating machine. Can you imagine annual 6% gains. That’s over $6000 in tax free money. $500 a month! Who’s rich now?
If your TFSA is stuck in a savings account, seriously consider switching it to a brokerage account. If you’re totally unsure as to what you are doing, start with something simple like Wealthsimple or the Couch Potato portfolios. You can never really go wrong with those.