Make better TFSA investment decisions and stop picking stocks that cost you more money than you earn.

Your tax-free savings account, or TFSA, can generally hold the same investments as an RRSP. This includes TFSA investment options of cash, mutual funds, publicly traded stocks, GICs and bonds.

These special savings accounts let you earn investment income, including interest, dividends and capital gains, tax free. But unlike contributions to registered retirement savings plans (RRSPs), contributions to TFSAs are not tax deductible. However, withdrawals from a TFSA are not taxed.

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Use TFSAs to hold lower-risk investments

Rather than aiming to set up a TFSA as a separate portfolio, we think that the best approach for investors is to treat all their holdings—regardless of what account they are in—as if they were all in a single account. That way, you can determine if the various accounts within a family are operating together, or at cross purposes. This also gives investors the overall perspective they need to make sound investment decisions.

However, we think you are best to hold lower-risk investments in your TFSA. That’s because you don’t want to suffer big losses in these accounts. If you do, you can’t use those losses to offset capital gains. You’ll also lose the main advantage of a TFSA: sheltering gains from tax. You won’t have gains to shelter if the value of your investments falls.

Find lower-risk investments for your TFSA with three tips that will earn you more money:

• Keep stock market trends in perspective. It pays to keep in mind that the stock market often anticipates trends—but no trend lasts forever. As well, stocks sometimes put on lengthy downturns due to business and economic problems—but the downturns typically go into reverse long before the problems get resolved.
• The best stocks should have the ability to profit from secular trends. These trends outlast ordinary business booms and busts, because they reflect ongoing social change. A growing middle class and rising environmental sentiment are just two examples of secular trends.
• Be skeptical of companies that mainly grow through acquisitions. Making acquisitions can speed up a company’s growth, but it also adds risk that can undermine a conservative, safe investing approach. Great acquisitions are rare finds. Many acquisitions come with hidden problems or risks, or they turn out to have been over-priced.

High-yielding U.S. stocks are not a good fit for your TFSA investments

Canadian shareholders pay a 15% withholding tax on dividends from U.S. stocks. If you hold the stocks in non-registered cash accounts, you can then get a Canadian tax credit to offset all or part of the tax you paid to the U.S. Better still, thanks to rules in the U.S./Canada tax treaty, the U.S. does not withhold the 15% from U.S. dividend income that comes to you from U.S. stocks you hold in an RRSP.

If you hold those dividend-paying U.S. stocks in a TFSA, on the other hand, the 15% tax is withheld. The U.S. wants its tax, and the latest U.S./Canada treaty doesn’t mention TFSAs, since they had not yet been created when the treaty was last updated. As a result, you lose the 15% withholding tax, but you don’t get an offsetting Canadian tax credit, since Canada doesn’t tax earnings from TFSAs.

So you won’t want to hold high-yielding U.S. stocks in your TFSA. In contrast, though, U.S. stocks that pay very low dividends or no dividends at all are okay to hold in your TFSA.

Make ETFs one of your top TFSA investment picks, to make more money when you’re first starting out

When you are first starting out with your TFSA, or making small monthly contributions, you could look to low-fee index funds for TFSA investing.

Over the years, as the value of your TFSA increases, you could switch those funds into a well-diversified portfolio of conservative, mostly dividend-paying stocks.

Focus on investment quality when looking for TFSA investment options and you’ll see better returns

When we look for investments, we zero in on companies that have established a business and have at least some history of building revenue and cash flow. We also look for companies that stand to benefit as the economy continues to improve, and have proven management and long-term growth plans.

That’s very different from so-called concept stocks, many of which are start-ups or companies that look to profit from next week’s or next year’s investor fad. These companies can generate big returns in a good year. In the long run, though, they are likely to cost you money.

Use our three-part Successful Investor approach when building your TFSA

1. Invest mainly in well-established, dividend-paying companies, with a history of rising sales if not earnings and dividends.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities.
3. Downplay or avoid stocks in the broker/media limelight. When stocks spend time in the limelight, they tend to become overpriced, and this leaves them vulnerable to a sharp downturn on any hint of bad news. Instead, look for stocks with hidden value that are less widely recognized—at least so far—as attractive investments.

Some analysts believe that increasing the TFSA contribution limit is a ticking time bomb because it would lead to significant losses in tax revenue. What are your thoughts on the contribution limits?

How has your TSFA changed over time? Do you have a plan that you stick to, or do you alter your strategy according to the current economic climate?