Nino D’Andrea, a 46-year-old general manager in Toronto, has been contributing to his Tax-Free Savings Account (TFSA) since its inception in 2010. With a TFSA totaling $62,000, D'Andrea has adopted a unique investment strategy - he focuses solely on Real Estate Investment Trusts (REITs).
In the past, D'Andrea had experienced both successes and failures in the stock market. He bought Nortel shares at a low price and sold them for a profit. However, he also made a poor investment in Encana, which resulted in significant losses. Determined to find a safer investment option as he approached retirement, D'Andrea turned to REITs.
D'Andrea's TFSA currently consists of a BMO Equal Weight REITs ETF (ZRE), which he has been steadily adding to over the years. This REITs ETF provides him with a monthly distribution of $263, allowing his TFSA to grow steadily. His goal is to reach a point where his TFSA will distribute $1,000 per month by the time he turns 65, supplementing his Canada Pension Plan (CPP) and Old Age Security (OAS) payments.
One of the significant advantages of D'Andrea's strategy is the tax-free nature of the TFSA. Without a TFSA, he estimates he would need $250,000 to purchase an annuity that would provide him with an annual income of $15,000. However, with his current approach, he will enjoy tax-free distributions during retirement without requiring such a substantial investment.
Although D'Andrea plans to continue working, even part-time, during retirement, he has no interest in extensive travel. Instead, he intends to spend quality time with family and friends, enjoy dinners out, and indulge in various sports activities in Toronto, where he is happiest.
Pro Tip: Beware of rising interest rates
Although D'Andrea's REIT-focused strategy looks promising, Jon Parry, a chartered investment manager, advises caution. Given his portfolio's 100% exposure to REITs, Parry suggests making some short-term adjustments due to rising interest rates. Higher interest rates can negatively impact REITs in two significant ways.
Firstly, the costs associated with borrowing for REITs rise, putting pressure on their profit margins. As leases for their properties are often locked in for defined periods, they may struggle to increase revenues or rents, leading to market punishment. Secondly, the volatility of REITs, including the ZRE ETF, is linked to the volatility of the underlying assets. If there is a significant correction in the housing market, the REIT's volatility may increase.
Parry recommends diversifying the portfolio by gradually adding global exposure through diversified ETFs. He specifically suggests looking into the BMO MSCI EAFE Index (TSX:ZEA), which invests outside of Canada and the United States. Additionally, investors concerned about the value of the Canadian dollar climbing can hedge by investing in ZDM, the currency-covered version of the ETF. Parry also mentions other reputable ETF providers such as First Asset Management and Vanguard.
For investors aiming for yield-focused investments, Parry suggests considering First Asset's U.S. & Canada Lifeco Income ETF (FLI) with a covered call overlay. Historically, Lifeco's have outperformed banks during periods of rising interest rates, making it a timely addition to the portfolio.
In conclusion, while focusing on REITs in a TFSA can be a lucrative investment strategy, it is essential to consider the potential impacts of rising interest rates. Diversification and careful selection of ETFs can help mitigate these risks and optimize returns.
Caption: Me and my TFSA