How to Use a TFSA to Maximize Your Returns

Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) is an excellence investment for your TFSA. Here’s why.

| More on:

The Tax-Free Savings Account (TFSA) is a wonderful tool for investors of any age (specifically 18 or older with a valid social insurance number) to use to protect their investments against tax collection from the Canada Revenue Agency. If you have never contributed to a TFSA, you could have as much as $63,500 contribution room this year! Based on a 7% rate of return, your investment can double in a little over 10 years and triple in less than 17 years.

The compounding effect makes your investments grow faster the longer your money stays invested, which is why it takes less time to triple than double your investment. So, generally, you want to invest your savings as soon as possible. Here’s how you can maximize your returns with the help of your TFSA.

question mark

How to use a TFSA to maximize your returns

Many investors have fixed-income investments, such as bonds or GICs as a part of their diversified portfolio. These investments generate interests. As interests are taxed at a high tax rate, some investors automatically choose to hold bonds or GICs in tax-sheltered accounts such as TFSAs.

If you live in Ontario and you’re in the third tax bracket, earning $47,630-77,313 this year, the tax rates for the interests, capital gains, and eligible Canadian dividends you’ll earn can be as high as 29.65%, 14.83%, and 6.39%, respectively.

If you earn $2,500 of interests on the $63,500, you’d be paying $741.25 of taxes if the amount was invested outside of tax-sheltered accounts. On the other hand, if you book 7% of capital gains and receive 3% of dividends from investing in stocks with the $63,500, you’d be paying nearly $780.92 of taxes.

Ultimately, your decision on what to invest in your TFSA should depend on your investment strategy (e.g., allocation to bonds and stocks), followed by the amount of taxes you’ll save by investing in one type of investment over another. As illustrated above, from a purely returns perspective, there’s no reason not to own quality dividend stocks, which tend to outperform long-term bond returns in your TFSA.

A proven dividend stock that’s priced at a discount

Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) has been positioning itself for growth. It made a number of acquisitions last year, including in Canada, Colombia, and Chile, which could be slightly dilutive in the near term, but should lead to higher growth in the future.

Moreover, it continues to invest in technology, such as automation, machine learning, and artificial intelligence with the goal of reducing costs, enhancing productivity, and reducing error rates. The returns of technological investments are difficult to gauge, but nonetheless, the spending should help expand margins and grow earnings.

BNS Chart

BNS data by YCharts. Bank of Nova Scotia stock outperformed the market in total returns and income in the long run.

Currently, at $74 and change per share, Bank of Nova Scotia still trades at a decent discount of about 15% from its normal multiple. And over the next two years, it could appreciate as much as 28%. Irrespective of its valuation, combining the international bank’s stable earnings growth of about 6% and dividend yield of about 4.6%, the bank should still be able to deliver long-term returns of more than 10% from current levels.

Investor takeaway

First, decide on an investment strategy (e.g.,)  allocation to bonds and stocks) that works for you, and then estimate how much taxes you’ll save by investing each in your TFSA. Historically, quality dividend stocks have outperformed other investments over the long term. Therefore, investors should seriously consider buying stocks like Bank of Nova Scotia, especially on dips, for their TFSAs. This will lead to decades of tax-free returns and dividend income!

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kay Ng owns shares of The Bank of Nova Scotia. Bank of Nova Scotia is a recommendation of Stock Advisor Canada.

More on Dividend Stocks

Make a choice, path to success, sign
Dividend Stocks

Is Fortis Stock a Buy for its Dividend Yield?

Fortis has increased the dividend for 51 consecutive years.

Read more »

Middle aged man drinks coffee
Dividend Stocks

Is Brookfield Stock a Buy, Sell, or Hold for 2025?

BAM stock recently jumped after beating earnings. But is it still a buy, or is it better to wait?

Read more »

Electricity transmission towers with orange glowing wires against night sky
Dividend Stocks

3 Top Canadian Utility Stocks to Buy in November

Are you looking for some top Canadian utility stocks to own? Here's a look at three must-have options for any…

Read more »

View of high rise corporate buildings in the financial district of Toronto, Canada
Dividend Stocks

Is First Capital REIT a Buy for its 4.8% Yield?

First Capital is a REIT that offers you a tasty dividend yield of 4.8%. Is this TSX dividend stock a…

Read more »

TFSA (Tax free savings account) acronym on wooden cubes on the background of stacks of coins
Dividend Stocks

TFSA Passive Income: 3 Stocks to Buy and Never Sell

Stocks like Fortis Inc (TSX:FTS) are worth holding long term.

Read more »

Electricity transmission towers with orange glowing wires against night sky
Dividend Stocks

Canadian Utility Stocks to Buy Now for Stable Returns

Given their regulated business, falling interest rates, and healthy growth prospects, these three Canadian utility stocks are ideal for earning…

Read more »

nuclear power plant
Dividend Stocks

The Best Canadian Stocks to Buy and Hold Forever in a TFSA

TFSA investors can buy and hold these Canadian stocks to generate above-average, tax-free returns over the next decade.

Read more »

Person holding a smartphone with a stock chart on screen
Dividend Stocks

Is Telus Stock a Buy for its 7.3% Dividend Yield?

Although the 7.3% dividend yield Telus offers is attractive, it's just one of many reasons why the telecom stock is…

Read more »