This approach eliminates the risk of holding individual stocks that could go bankrupt over time. In fact, just a handful of companies are responsible for the majority of stock market returns, making holding individual stocks even riskier. Instead, passive investing allows you to harness the power of global economic growth and compound interest over time.
Whether you prioritize maximizing your Tax-Free Savings Account (TFSA) or building your Registered Retirement Savings Plan (RRSP), the approach remains the same.
In this article, I’ve identified two simple index funds that Canadian investors with a long-term investment horizon can buy and hold now.
Diversified index funds are products that have the ability to turn modest monthly contributions into a seven-figure portfolio over time. Compared to active funds, passive exchange-traded funds (ETFs) are cheaper, with lower expense ratios and management fees.
The majority of Wall Street asset managers fail to beat the underlying index, which is why assets under management for passively managed funds have increased over the past two decades.
Two TSX Index Funds to Buy Now
The first fund to consider is iShares Core Equity ETF Portfolio (TSX:XEQT), a globally diversified stock portfolio with thousands of stocks from multiple countries and sectors.
Canadian investors often suffer from home country bias and may have significant exposure to domestic companies dominated by blue chip banks and energy companies.
However, they are missing out on the international technology giants, healthcare innovators and consumer brands that are driving global growth. XEQT is a diversified ETF that gives you exposure to some of the largest companies in the world.
The second fund is Vanguard S&P 500 Index Fund (TSX:VFV), which tracks the S&P 500 index. The US economy has historically been the driving force behind global growth, and this fund provides concentrated exposure to the massive technology companies that dominate the global economy.
The fund is also unhedged, meaning you’ll benefit if the Canadian dollar weakens against the U.S. dollar over time, a trend that has occurred repeatedly over the past few decades.
How to Build a $1 Million Portfolio
If you invest $500 every month for 35 years, given an average annual return of 8%, you can accumulate $1 million. Increasing the monthly contribution to $1,000 drops the time horizon to 26 years, while an investment of $2,000 will help you reach your $1 million goal in 18 years.
The remarkable part is how that $1 million is accrued. In the $500 monthly scenario, you contribute $210,000 of your own money over 35 years. The remaining $790,000 comes entirely from market growth and compound interest. Almost 80% of your wealth comes from the market doing its work, and not from your salary.
The vehicle you choose is just as important as the strategy itself, so try to prioritize your TFSA. A million-dollar portfolio is impressive, but a million-dollar tax-free portfolio is life-changing.
When you build this wealth in an RRSP, the government actually owns some of it. When you withdraw money from the RRSP in retirement, it is taxed as income and, depending on your tax bracket, you could lose $300,000 or more in taxes.
First, maximize your TFSA and try to reach the annual contribution limit of about $7,000, which works out to about $583 per month. Once your TFSA limit is reached, you can deposit any excess funds into your RRSP to reduce your current taxable income.
The hardest part of this whole strategy is doing nothing. So automate your monthly contributions, stop checking stock prices daily and let the power of compounding work its magic.
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