36. 5 Steps to set up your TFSA for 2022
Transcript:
Hello, and welcome back to the Canadian Money Roadmap podcast. I'm your host, Evan Neufeld. Today we are back with our first episode of 2022, and we're going to look at a five step system for setting up your TFSA for investing this year.
As I mentioned in the intro there, this is our first episode of 2022. Thank you so much to all of you who are returning listeners. Anyone that's new, welcome here, of course, but thank you so much for all of you who tuned in, in 2021 and made our show as successful as it was. I'm really happy with the growth that we've seen and to how many of you have reached out by email and whatnot. I really appreciate hearing all those stories. Well, along with a new year comes more TFSA contribution room. So I thought this would be as good a time as any, to do another episode talking about TFSA’s and how best to maximize them. So this year I'm going to be focusing on setting up a system for your TFSA and so this episode will showcase a five-step system for evaluating how to invest in your TFSA in a way that's appropriate for you. And some practical steps you can take to actually get there.
I really like TFSA's and I focus a lot of my content on using TFSA's because I think it's honestly hard to overstate how valuable the TFSA is and will be for people when it comes to their long-term plan. And the simple fact is that most Canadians aren't using them to their full potential. So I'm going to keep beating this drum as long as I need to, to make sure that people are getting the most advantage here as possible. So without further ado, let's get into it. So five step system for your TFSA in 2022, first things first, before you start investing or look at any funds, ETFs, stocks, or anything like that. Let's take a step back and focus on the first thing.
So step number one here. Let's evaluate your objective. Evaluating your objective we'll make sure that you are investing in such a way that you won't be overexposed to risk, but it also gives you some timelines to make sure that you know when to get out and what the purpose is. So I find that most people, if they have a defined purpose for their investments, they're less likely to make rash decisions when the market moves around and they're more likely to stick to their plan for the duration of time that they need to. So, if you're taking a look at a short-term goal or a medium term goal or a long-term goal, you need to know what it is that you are trying to invest for. But let's break that down a little bit because we could have some disconnects on what short, medium, and long-term means. We had a client here in the office one time and we were asking about long-term goals and she said, well, over the next year I'd like to do X, Y, and Z. And we thought, oh my goodness, we have a disconnect in what we're referring to when we mean short, medium and long-term. So talking about short-term goals, generally speaking, that's probably within a year, maybe two years. There isn't a formal definition here necessarily, but a year or two is short-term when we think of investing. When we think of a short-term goal would typically be something like saving for your next vacation, maybe for a car, big Christmas gift for somebody, maybe some furniture around the house, maybe your renovation, things like that. Generally speaking, I don't recommend you invest money that you're going to need over this period of time. If you have already listened to some of my other episodes on TFSAs you'll know that I'm a big believer in using your TFSA for investing, not for parking cash, because the tax free portion is only important if there is money that has been made because you only pay taxes if you make money. And if it's just sitting there in cash, it might as well just be in a checking or savings account and not wasting space in your TFSA. So if you are saving for a short-term goal, don't bother using it at TFSA, don't bother investing it. That should be in say a high interest savings account, potentially something like that.
Next medium term, I would say that's probably in that two year up to five-year range. So this is more often than not the down payment on a house. That's a big purchase that you want to be planning for, for a while. Maybe the next car if you're wanting to pay with cash. It takes a few years to save up for most vehicle payments, especially the way prices are these days. But once you're in this medium-term range, this is when you can start adding a little bit of risk to your portfolio because you have a few more years out before you actually need to start spending the money. This isn't where you want to start looking at a hundred percent stocks necessarily, but adding something like bonds, maybe a few stocks in there. Maybe a smaller percentage, maybe 25% of the accounts, something like that might be a bit more appropriate for a medium-term goal.
Now long-term goal. This is more what people traditionally think of as retirement or maybe their financial freedom number or an independence number, something like that. This would be a five-year plus goal and largely for most people, this is going to be a 15, 20 year plus. This is when you can afford to have more risk within the portfolio, because you have more time in between now and when you're actually going to need the money. So if it goes up and down in value today, it doesn't matter necessarily because you've got so many years in front of you before you actually need to spend the money. So without going too far on this one here, this is just step number one. You need to evaluate what your objective is, whether that's a short, medium or long-term goal, and that will help determine how you can invest your money. And I'm going to come back to that part later on.
Step number two. Before you can start investing, you need to know how much you can actually contribute to a TFSA. So to figure out your contribution room, there's a variety of different ways that you can go about doing that. And for the purposes of this podcast, I'm going to assume that you, as the listener have never used a TFSA before, and you have all the contribution room that you would personally be allowed. So if you are at least 31 during this calendar year of 2022, you'll have the maximum TFSA room of $81,500 and you can invest all of that at once. If you had that much cash sitting around, yes. You could put all of that into your TFSA in at one time. But as I mentioned off the top, every year, you get additional contribution room. That's not your specific limit for that year necessarily, unless you've already maximized your room. So let me explain that a little bit more. So every year that after you turn 18, you accrue TFSA contribution room. When it first started in 2009, you got $5,000 a year. In 2010, there's another $5,000. And so if you hadn't opened one or you used one yet, you'd have 10,000 of room as of 2010. Okay. Hopefully I'm not using too many numbers here and you stay with me, but if you don't use it, you don't lose it. It accrues over time and you can always make up for lost time in the future. So again, if you are at least 31 years old in this calendar year 2022, you'll have the maximum room of 81,500. If you are listening to this, and you're currently younger than that, you won't qualify for the whole maximum, but you accrue your room based on when you turned 18. So I'll have a link in the show notes below over to my blog, where you can see a chart and you can see, how much room was available in certain years and then you can kind of add it up from there to see how much room you have.
Alternatively, if you don't want to do the math on this and the reason we have to do math, actually, maybe I'll backtrack a little bit is because the contribution room has changed. A number of times, we went from 5,000 to 5,500 and then there was a crazy $10,000 year and back to 5,500. And now up to 6,000. So the math gets a little bit complicated depending on your age. So it's worthwhile to actually look into seeing how much room you have based on your age. But if you log into your CRA account online as well, you can find your contribution room there. The thing that you want to be careful of is making sure you look at the date that the report is valid as of. So generally speaking, it'll say as of January 1st, 2021, you'll have X amount of room, but if you've already been contributing to a TFSA they don't necessarily report your contributions to the plan until up to 12 to 15 months after it's happened. And so you just have to be really aware of what date is being shown on the report on CRA. It's not inaccurate, it's just delayed typically. So you might want to keep track of your own contributions to the plan or take a look at your brokerage account or talk to your advisor, whoever you use to invest your money. When you can do some backwards looking to see how much you've contributed over the years, but this is step number two. It's complicated because sometimes it is complicated. So number two, understand your contribution.
Okay. So now that you've figured out your objective, how much room you have to contribute, number three is understanding your risk profile and asset allocation. So I'll be a little bit more brief here because this is related to step number one, but I recommend that you go through a process of actually going through something called a risk tolerance questionnaire. I'll have a link to one in the show notes here from a company called Vanguard. If you're a do it yourself investor, you've probably heard of Vanguard before. I have no personal affiliation with them or anything like that. This isn't a recommendation of their products per se, but they're a company that's trustworthy and that they have a really good questionnaire. If you go to the link I have below, you'll be able to answer a number of questions there and they're hypothetical's, you know, The market dropped by this percentage, what would you do? It'll ask some timeline type questions and things like that. And then at the end, they'll give you a result based on how much either stocks or bonds that you should have based on how you answer the questions. So some of the questions are more feelings based and some of them are a little bit more objective. I think it's a really good way to actually determine how much you should have in each different place based on your objectives and your timeline. So say for example, you go through the questionnaire and you end up with an asset allocation of 60% stocks and 40% bonds. That's what we would usually call a balanced investor. So it's a bit of a balance between those two major asset classes.
Then you can take that information and purchase investments appropriately. So sometimes there are products that are just kind of a one-stop shop. We call those a balanced fund or a balanced ETF, and it'll do it for you. Or if you're doing a little bit more of a DIY approach, you could purchase enough bonds or stocks to build that asset allocation yourself. Or if you work with a broker or an advisor to do it for you. I'm sure they've done a questionnaire or even an informal questionnaire where they've determined an asset allocation with you already, but it might be worthwhile to have a second conversation about that kind of thing, just to make sure you're on the same page. Okay. That's step three. So you've figured out what your risk profile should be and how that determines how you should be investing now.
Number four, this is where the rubber actually meets the road and you need to go open a TFSA. So there's a variety of places that you can do this. Many people have them at their local bank. The problem with doing it at the bank is that depends on who you talk to, they will assume that this is more of a tax-free savings account for cash, as opposed to a tax-free investing account. That's not what it's actually called, so don't request a tax-free investing account, but the banks have been huge proponents of opening TFSAs for the purpose of parking cash and that's just not the highest and best use of the TFSA. But if you have a good relationship with your person at the bank and that's where you feel comfortable, no problem at all, you can open a TFSA there. There's also robo-advisors now you might've heard of that type of thing. Maybe products like wealthsimple, Quest trade, there's a few other programs that would offer this type of thing. You can open the TFSA with them, and kind of take it from there. If you're going that route, they will probably have to do the risk tolerance questionnaire for you and so you'll probably end up doing step three again with them. Shouldn't be a problem, but just so you know, that you typically can't bring your own risk profile to the table. If they're the ones administering the investments for you. So if you're doing a robo-advisor, that's how that process is going to work. A third option is going completely DIY. And so this wouldn't be a robo-advisor per se, but you could go through something called a discount brokerage. So you set up an online account with a trading platform and you can buy and sell stocks, bonds, ETFs, mutual funds yourself and you can do it that way. And the last option is you can do it with an independent advisor, so they could open a TFSA and invest in any number of products on your behalf. So if you have someone, you know, like and trust there, give them a shout and see if they can take care of that for you.
Along with opening the plan is you actually have to get some money into it. And so going back to the understanding your contribution room thing, if you have tons of contribution room and tons of cash lying around, well, that's fantastic, I’d like to have your problems, but most people generally have cashflow every month from working and so what I recommend for people to do, if they're just starting out with the TFSA is to make contributions automatically. So as you get more money every month, invest a little bit of money every month. And so with most of the methods that I mentioned before, you have the opportunity to automate how you contribute to your TFSA and then subsequently investing within your TFSA. It's a lot of different thoughts about things like this. If you are sitting on cash and you have contribution room to do it, history says that it is better to have the money invested right away instead of picking away at it. But if you are just investing as you get cashflow every month from working, doing a regular contribution does make a lot of sense, too.
We refer to that as dollar cost averaging because if you're contributing on a regular basis, the market is going to go up and the market's going to go down, but because you're buying at regular intervals, you'll end up buying the average price over a long period of. It's a good way to do it. It kind of smooths out the bumps in the road. And, especially for those people that aren't sitting on a big pile of cash, it's a really nice way to invest, to make sure that you're not getting hurt by the movements of the market on a regular basis. To really take advantage of that in the best way, I really recommend that people do smaller contributions more. Double check with the way that you're investing to make sure that you don't have transaction fees associated with this because of course more transactions means more costs there, but if you have no fees to do regular contributions, I would recommend you go as frequently as weekly.
So say every Friday you make a contribution into the plan. That way it doesn't have one singular hit on your bank account or your budget. And it's a lot easier to make sure that you are able to benefit from short-term movements of the market. So as I'm recording this today, markets have been down generally for about five days in a row, and you never know they might be up for the next five days, but if you're contributing every week, you'll actually be able to benefit when the market goes down over a short period of time. So that's step number four, that's opening the plan and making your contributions to the plan. Again, I highly recommend that you open it and then automate it as soon as you possibly can.
And number five is monitoring it. So that doesn't mean turning on CNBC and watching that every single day or having a little ticker bus going on your computer or anything like that. Set it and forget it is a great policy when it comes to long-term investing in particular. But when I refer to monitoring, you can have a look at a few different things. One of them I would say is rebalancing and depends on the investments that you're using. Some of them might rebalance automatically, but I'll just explain the concepts so you know what I'm talking about. So say the markets are really positive and when I say the markets, I generally mean the stock markets. So when stocks go up, bonds usually don't go up at the same pace. And so what can happen is over time, your portfolio might've started at 60/40, but then next time you look a few months or a few years later, it might end up being 70/30, just because the stock portion has grown so much faster. And so when you get to a 70/30 allocation, but your risk preferences that you should be at a 60 40, that might be a good time to rebalance. Which means that you'd want to sell 10% of your stocks and buy 10% more bonds and so then you can end up back at that 60/40. When you're using diversified portfolios, like ETFs, mutual funds, things like that, I feel much more comfortable doing this. If you're doing an individual stock portfolio. You can really run some serious risks where you end up doing something called watering your weeds. If you have, a few losers in the portfolio, there is a chance that you might just be throwing good money after bad stock, that's never going to come back or it just kind of was a highflyer at one point, and now it's worth nothing, but you just keep buying it and keep buying it. That's not really diversification and that's not really what we're going for here. And so generally speaking, rebalancing works the best when we do it between diversified portfolios, broad market indexes, things like.
When it comes to rebalancing, I had a whole episode on this, but I recommend setting up an automated system to do that. Or at least even a reminder system. Take a look every quarter, take a look every year, something like that, but on a semi-regular basis, have a look to see if anything's out of whack and then you can rebalance accordingly, to do it manually introduces other risks of introducing your feelings into that. And so, you know, say the market looks really bad one day, you might do it more often than you really should. Again, if you have transaction costs, that can be problematic too. You don't want to do it too often if that's the case. But make sure you have a look at it occasionally to make sure that your risk doesn't run completely out of whack as to where it should. Some people don't like to sell their winners, but I think it was Warren Buffett, though it might've been someone else, but he said no one ever lost money by taking profits. So that's a good thing to keep in mind to keep everybody humble.
The last thing, when it comes to monitoring your investments is actually keeping track of when and how you withdraw. So because it's a tax-free savings account. There's no tax when you earn money within it. So if your investment grows in value, if it pays a dividend, if it pays interest, anything like that, you don't pay any tax on it. But also when you withdraw, if, when you withdraw your money, you don't pay tax on anything at all. It won't even touch your tax return, nothing at all like that. But you do want to keep track of how and when you withdraw, just so that you understand how you can re-contribute that money again. So let's use a hypothetical example here.
Let's say, for example, you've fully maximized your TFSA in January and you take $5,000 out of the plan in April. The way that the re contribution rules work is that you can't put that $5,000 back into the market until the next calendar year. So even if you have 5,000 available to invest in say, November of that same year, you can't do it yet. Or else you will over contribute to the plan. So whenever you make withdrawals, you can't re contribute that money until the next calendar year. So if you're wanting to be strategic for whatever reason, if you're making a large withdrawal from your plan, And you have flexibility on when you can do it. I recommend doing it in December, because if you take, say that $5,000 out in December, you don't have that much longer to wait until you can re contribute the money back into the plan in January. Of course, if you need the money, to take the money out. But if you're trying to be strategic about it, taking money out in December leaves the least amount of lag time between when you make the withdrawal and when you can contribute it back into the plan without any penalties.
So let me summarize that again and starting from step number one, first things first kind of figure out what you're doing. Why are we doing this? This is your objective. Why are you investing in your TFSA? Step number two, understand your contribution room. You can do the math yourself, you could go to CRA, but just double check that you understand when your contribution room started, what you've already done and what date is on the report if you're getting it from CRA. Step number three, evaluate your risk and asset allocation. Meaning how much should you be investing in stocks and bonds based on your feelings on things, some objective metrics like your timeline and your risk capacity. Step number four, go open the plan, and then start making contributions. If you can automate them and make regular contributions to the plan, that's great. Finally, you want to monitor your new TFSA by rebalancing occasionally and keeping track of your withdrawals whenever that might happen. So if you follow these five steps, you should be in a really good shape to make sure that you're taking most advantage of your TFSA for this year and not over contributing, not over risking, things like that, that really get people in trouble.
The TFSA is such a great tool to use for long-term planning. I really want to make sure that you get it right this year, but if you have any questions or if I confused you with any of these steps along the way, feel free to reach out to me. My contact info is in the show notes as usual, or you can head over to my website at www.evanneufeld.com.
Thanks for listening to this episode of the Canadian Money Roadmap podcast. Any rates of return or investments discussed are historical or hypothetical and are intended to be used for educational purposes only. You should always consult with your financial, legal and tax advisors before making changes to your financial plan. Evan Neufeld is a Certified Financial Planner and Registered Investment Fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc.