What is a Self-Directed TFSA & How it Works

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Danielle Kubes is a trained journalist and investor who has written about personal finance for the past six years. Her writing has been published in The Globe and Mail, National Post, MoneySense, Vice and RateHub.ca. Danielle writes about investing and personal finance for Wealthsimple. She has a Bachelor of Humanities from Carleton University and a Master of Journalism from Ryerson University.

Canadians wept for joy when the late Jim Flaherty, the then federal Minister of Finance, introduced the tax-free savings account in the 2008 federal budget. Okay, maybe only personal finance nerds wept for joy… or at least smiled because we finally had a flexible account where our money could flourish, protected from the long-reach of the CRA.

The beauty of the TFSA, as opposed to the RRSP, is that we’ve already paid tax on any contribution.

Having done our civic duty, we can withdraw funds at any time without further burden. So if you deposit $6,000 today and manage to grow it over 20 years to $13,000, you can take it all out scot-free.

Not that it’s a competition, but TFSAs have proved pretty popular for Canadians—over 40% of uscontribute to a TFSAs, whereas only 35% contribute to an RRSP.

And we’ve contributed a lot: $54 billion by 2016.

Invest in your TFSA

But Canadians are smart—they know that if they simply contribute—just deposit money and let it sit there—they’re totally missing out on the true value of the TFSA. The “S” in TFSA confuses people, they think it’s a savings account and that you use it to save for a wedding vacation or a down payment. Flaherty was a super smart guy, but we think he made a mistake on this one. He should have named it the TFIA for tax-free-_investment-_account.

Many Canadians appear to have mentally switched out the “S” for an “I”, because they’ve managed, in just one decade, to grow their $54 billion dollars of deposits to $232 billion of assets. \That means that Canadians more than tripled the value of their money in under 10 years.

They clearly get that taxes can eat up returns like nothing else, not even fees. It’s like staying up all night baking and then opening the door to Cookie Monster and letting him chomp away at 20-50% of your baked goods while they’re still in the oven. And the police are standing there making sure you don’t stop him.

So while saving is fine—and something we absolutely should be doing—we can do that in any regular old account. In order to take advantage of the TFSA, in which no interest, dividends or capital gains are taxed — we need to invest.

Investing in a variety of stocks and bonds without timing the market should net you about a 4-5% return over 15 to 20 years—growth that’s all yours to keep. Returns in each year may swing wildly in either direction, but over the long-term it should balance out, and almost certainly grow more than cash. Besides, long-term is what the TFSA is all about since day trading, which we would never recommend, is penalized anyway.

So how do you get in on this investing action? One of the best ways is to open a self-directed TFSA .

What is a self-directed TFSA

You pick and manage your investments in a self-directed TFSA. It’s virtually identically to dealing with any other type of do-it-yourself brokerage account, save for the contribution limit and the fact you won’t be taxed on any accumulated growth.

You open a TFSA, contribute funds and select investments. It’s perfect for confident, knowledgeable investors with time to devote to investing.

Those for whom the markets remain a tangled web of blurry numbers and strange acronyms they have no desire to decipher may want to consider an automated investing platform.

They still count as a self-directed TFSA because you’re not buying a specific product with a specific term length—instead, you’re simply letting an algorithm do the nitty-gritty of managing a portfolio. It’s like having that robot vacuum that crawls along on the floor sucking up all the dirt so by the time you get home all your cat hair is gone and you haven’t had to lift a finger. But you can turn the robot off and on according to your schedule.

Similarly, after figuring out your risk tolerance, the algorithm selects a suitable basket of exchange-traded funds and then manages them for you—all that buying, selling, rebalancing and reinvesting we spoke about earlier. All you have to worry about is earning the money to contribute.

Algorithms are cheaper than humans, so the fees are usually extremely low, under half a percent.

What investments can go into a self-directed TFSA

Remember: Your TFSA is simply an account, an empty shell. It’s not a product in itself. It’s value lies only in what investment product you choose to purchase within it. Luckily, virtually any publicly-traded investment can go in a self-directed TFSA.

Here’s a sample

  • Stocks

  • Bonds

  • Exchange-traded funds

  • Mutual funds

  • Cash

The alternative to self-directed TFSAs

The alternative to a self-directed TFSA is purchasing a TFSA investment product from your bank. Currently, those products are almost always limited to a GIC or a mutual fund. While these are also set-it-and-forget-it purchases, purchase, they tend to be old-fashioned with significant downsides.

Why lock-up your money in a GIC, for example, when you can stockpile cash in a high-interest savings account? It’s equally low risk, but allows you to retrieve your money at any time. And if rates rise, you’ll earn more.

As for mutual funds, the selection offered by the banks are quite limited—you’re required to pick from a short list of proprietary funds. If mutual funds are your thing, you can easily purchase one in a self-directed account. A far larger range is available on the public stock exchange, and you can trade them like any other equity. You’ll also side-step any conflict of interest—it’s perfectly ethical for bank-employed financial advisors to sell you a fund from which they earn a higher commission, even if another fund would work just as well, or better for you.

Of course, if you have enough contribution room, you can have multiple self-directed TFSAs, in addition to a GIC or mutual fund product.

How to open a self-directed TFSA

The process to open a TFSA is similar to opening any other type of account at a financial institution. You can sign up online in as little as 5 minutes and start protecting your investment growth from taxes today.

Last Updated April 25, 2022

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