Canadians can create a steady stream of tax-free passive income in a TFSA (Tax-Free Savings Account) by investing either in Guaranteed Investment Certificates (GICs) or high-yield dividend stocks.
The TFSA is a registered account that was introduced in 2009, which allows you to hold a variety of qualified investments, including bonds, stocks, GICs, mutual funds, and exchange-traded funds. Moreover, any returns in the form of dividends, capital gains, or interests are sheltered from Canada Revenue Agency taxes.
So, let’s see where you should invest to create a passive-income stream in a TFSA.
What are GICs?
A GIC is an instrument that lets you earn interest on your deposit amount, which is generally locked in for a specific time period. Similar to a savings account, you can gain access to GICs at a bank or a credit union.
Several banks in Canada currently offer you an annual interest rate of more than 5% on GICs, which is quite attractive, given inflation rates have cooled off. So, you can generate inflation-beating returns by investing in a low-risk instrument such as a GIC.
Additionally, GIC deposits (up to a certain amount) are protected by the Canadian Deposit Insurance Corporation, or CDIC.
A unique benefit of GICs is it provides you with an option to lock in a favourable interest rate. As interest rates have risen in recent months, you can invest in a GIC and secure an attractive yield on your deposits, which is much higher than your savings account.
Dividend stocks offer capital gains, too
There are several dividend stocks in Canada that offer shareholders a yield of more than 5%. But as dividends are not guaranteed, the risks associated with investing in high-dividend stocks are huge.
In the past year, several TSX stocks were forced to lower dividend payouts due to deteriorating financials. So, it’s crucial for you to create a portfolio of dividend-paying companies that have the ability to generate stable cash flows across business cycles.
For instance, TSX energy giant Enbridge (TSX:ENB) currently offers you a dividend yield of more than 7%. Further, these payouts have risen by 10% annually for 28 consecutive years, showcasing the resiliency of its business model.
Enbridge is a well-diversified energy infrastructure heavyweight that benefits from its large network of pipelines, providing the company with an enviable competitive moat. A majority of its EBITDA (earnings before interest, tax, depreciation, and amortization) is tied to long-term contracts, which are indexed to inflation, shielding Enbridge from fluctuations in commodity prices.
In addition to a high yield, ENB stock offers shareholders to benefit from long-term capital gains. In the past 20 years, ENB stock has returned 258% to investors. After adjusting for dividends, cumulative returns are over 750%.
The Foolish takeaway
Whether you need to invest in GICs or high-yield dividend stocks depends on a number of factors, such as your age, risk appetite, and investment horizon.
For individuals nearing retirement and with a low-risk appetite, investing in GICs is advisable. Alternatively, high dividend stocks are ideal for those bullish on equities with an investment horizon of at least five years.
You can also choose both these asset classes and diversify your investments, which lowers overall risk.
