TFSA strategies

“I can’t get that information for you right now,” my broker’s assistant said. “The system is jammed up — we’re getting a flood of contributions to RRSPs and TFSAs and they’re slowing down everything.”

It’s nice to know that people have money left after the holidays to invest but I was a little surprised that she mentioned Tax-Free Savings Accounts. This is certainly RRSP season and we only have until March 1 to make contributions that qualify for a 2010 tax deduction. But there is no cut-off for TFSAs. I can only assume that a lot of people are anxious to take advantage of the additional $5,000 in contribution room that became available on Jan. 1.

This is the start of the third year of the TFSA era so most adult Canadians now have a cumulative total of $15,000 in contribution room ($30,000 per couple). The exceptions are recent immigrants and those who were under 18 when the program was launched on Jan. 1, 2009.

At these contribution levels, TFSAs finally have some financial heft. The issue is using them to maximum effect.

As I see it, the optimum investment strategy for a TFSA is quite different from that for an RRSP. The latter is a retirement fund, a mini pension plan if you like. It should be managed conservatively, with a view to protecting capital. It is also important to keep in mind that all the money in an RRSP will eventually be taxed. There’s no escape.

A well-designed RRSP should consist of a mix of fixed-income securities, stocks or equity funds, and a small amount of cash. Speculation should be avoided. Remember what happened during the stock market meltdown of 2008-09. The media was full of stories about people who had overloaded their RRSPs with stocks. Having suffered heavy losses, they were forced to revisit their retirement plan and, in some cases, to postpone the target date for stopping work. That’s not the way an RRSP should be managed.

TFSAs are a different matter. They don’t yet have the critical mass to be a viable alternative to RRSPs, which have much higher contribution limits. So unless they are intended strictly as an emergency fund, I suggest they be managed in such a way to maximize the potential tax savings. That means taking more risk than would be prudent in an RRSP.

Frankly, I cannot understand why anyone would hold GICs in a TFSA at a time when interest rates are so low. The tax saved is minimal (a 3 per cent return on $15,000 is only $450 a year) and by locking in the money you lose liquidity.

My personal approach is to invest in aggressively managed mutual funds that are suitable for the current environment and have the potential to generate well above average returns. Of course, the potential for loss is higher as well but as long as your retirement savings are on the right track I think it’s worth the risk.

For readers who want to use this approach for their TFSA, here is one suggestion. Ask a financial advisor if it is suitable for your account.

Front Street Growth Fund. Despite the recent pull-back, I expect oil prices to top US$100 by mid-year and metals prices to continue to move higher. Unless you want to speculate in the commodities markets, the best way to maximize profits from these trends is by holding a portfolio of small to mid-cap energy and mining stocks. You can always pick them yourself but I prefer to have one of the best in the business do it for me: Norm Lamarche, who runs this high performance fund. He took it over in late 1999 and as of Dec. 31 his 10-year average annual compound rate of return was 22.2 per cent. You won’t find much better than that.

However, this can be a roller-coaster ride. Most years, the fund produces double-digit gains but when the bottom fell out of the markets after the Lehman Brothers collapse in 2008, this fund dropped more than 50 per cent. The good news is that Mr. Lamarche more than recovered those losses in 2009, ending the year with an overall gain of almost 130 per cent.

If we begin seeing signs that a new recession is brewing, get out of this one fast. But if the global recovery continues, the rewards here could be impressive. The closing NAV on Jan. 19 was $10.86.

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