Any Canadian who was at least 18 years old in 2009 now has up to $52,000 in available contribution room in his or her tax-free savings account (TFSA).
The TFSA is useful for investors of all ages, but those who can really take advantage of the benefits are Canadians with decades ahead of them before they retire.
Why?
The TFSA allows investors to buy dividend-growth stocks and collect the distributions without having to worry about setting aside some of the payouts for the taxman.
When those distributions are reinvested in new shares, the investor sets off a powerful compounding process that can turn a small initial investment into a significant pile of money over the course of a few decades.
When the time comes to cash out, all of the capital gains on the stocks are also tax-free!
How much can investments grow?
Let’s take a look at Fortis Inc. (TSX:FTS)(NYSE:FTS) and Royal Bank of Canada (TSX:RY)(NYSE:RY) to see how the system works.
Fortis
Fortis owns natural gas distribution, electricity generation, and power-transmission assets in Canada, the United States, and the Caribbean.
The company gets 94% of its revenue from regulated assets, which means cash flow should be both predictable and reliable.
Fortis has a strong track record of successfully integrating acquisitions, and that trend continues with the recent US$11.3 billion purchase of ITC Holdings Corp.
The company has raised its dividend every year for more than four decades, and management plans to hike the payout by at least 6% per year through 2021.
The current dividend provides a yield of 3.9%.
A single $25,000 investment in Fortis 20 years ago would now be worth $450,000 with the dividends reinvested.
Royal Bank
Royal Bank earned more than $10 billion in profit in fiscal 2016. Yes, you read that right, TEN BILLION!
The company is a monster in the banking world — not just in Canada, but globally.
As the Canadian economy works its way through a rough patch, Royal Bank is focusing new investments south of the border. The company spent US$5 billion in late 2015 to buy City National, a California-based commercial and private bank.
The deal provided Royal Bank with a strong platform to expand its presence in the segment, and investors might see more acquisitions in the coming years.
Like Fortis, Royal Bank has a strong track record of dividend growth. The current payout provides a yield of 3.6%.
What about returns?
A $25,000 investment in Royal Bank just 20 years ago would be worth $445,000 today with the dividends reinvested.
The bottom line
A couple that put $50,000 in these two companies 20 years ago would now be sitting on $895,000. That’s a nice little nest egg.
While there is no guarantee that the next 20 years will produce the same results, the message is quite clear: owning dividend stocks and reinvesting the distributions can make you rich.
For today’s young investors, the TFSA makes the strategy even more appealing because all of the gains go straight into your pocket!
