For prospective home buyers in Canada, navigating the challenging real estate market just got a bit easier with the introduction of the First Home Savings Account (FHSA).
This innovative account offers a unique combination of benefits borrowed from both the Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA).
If you’ve just opened your FHSA in 2024, you’re eligible to contribute up to $8,000. For those who opened an account last year but didn’t fully utilize their contribution room, there’s an opportunity to carry over the unused portion, allowing a total contribution of $8,000 minus any amount previously contributed.
In this guide, we’ll explore the best investment strategies for your FHSA, helping you to navigate this crucial saving tool effectively.
FHSA vs. RRSP vs. TFSA
Like the RRSP, contributions to the FHSA reduce your taxable income, providing immediate tax relief. Simultaneously, it mirrors the TFSA in that dividends, interest, and capital gains earned within the account are not subject to tax.
But the FHSA’s advantages don’t end there. When you’re ready to make a qualified home purchase, you can withdraw funds from the FHSA tax-free to use as a down payment, making it an excellent complement to existing programs like the RRSP’s Home Buyers’ Plan (HBP).
It’s All About Your Time Horizon
To maximize the potential of your FHSA, it’s important to choose the right assets to hold within it, tailored to your specific time horizon.
Understanding your specific time horizon is crucial, as it directly impacts the level of risk you can comfortably take on in pursuit of investment growth.
What Are Your Homeownership Goals?
Homeownership goals vary significantly among individuals. For younger savers, the FHSA serves as an excellent vehicle to gradually save and invest while navigating through school and the early stages of a career. It offers a structured way to build up a down payment over time, while also reaping tax benefits.
On the other hand, older individuals who may already have substantial savings can use the FHSA to their advantage as well. It allows them to set aside funds, enjoy tax deductions, and strategically reallocate these savings for future home purchases.
How Long Is Your Time Horizon?
However, it’s important to emphasize that the amount of time you have until you plan to buy a home will largely dictate your investment approach. Generally, the longer the time horizon, the more risk you can potentially afford to take, as you have more time to recover from any market downturns.
Let’s consider three distinct scenarios to illustrate this point: purchasing immediately, purchasing within 1-4 years, and purchasing within 4-10 years.
FHSA Contribution: Purchasing A House Immediately
If you’re on the cusp of buying a house and considering using the FHSA, there’s still a significant advantage to contributing to this account. One of the immediate benefits is the ability to deduct your FHSA contribution from your taxable income, offering some helpful tax savings.
The flexibility of the FHSA is particularly beneficial for immediate home buyers. The government stipulates that there is no minimum holding period for contributions or transfers into FHSAs before they can be used for a qualifying withdrawal.
This means you can contribute to the FHSA and almost immediately use those funds for your home purchase, enjoying the tax benefits without delay.
Given the immediate nature of your home purchase, it’s crucial to avoid speculative investments or options that could lock in your money. Liquidity is key – you need to be able to access your funds quickly and without penalty.
HISAs: The Recommended FHSA Investing Strategy For Immediate Home Purchase
For this scenario, consider using a dedicated FHSA high-interest savings account. These accounts are specifically designed to offer safety and liquidity, along with the added benefit of accruing interest.
Alternatively, exchange-traded funds (ETFs) that invest in high-interest savings accounts can be another prudent choice. These ETFs provide similar benefits to high-interest savings accounts, such as safety and the ability to easily sell and withdraw funds, while also distributing monthly interest.
Both of these options ensure that your funds are not only safe and readily accessible but also continue to earn some return, albeit modest, in the short period they are invested.
FHSA Contribution: Purchasing A House Within 1-4 Years
For those who are not quite ready to purchase a home but have a plan to do so within the next few years, the investment approach within an FHSA can be more strategic. In this scenario, a guaranteed investment certificate (GIC) is an excellent option for individuals with a concrete timeline of 1 to 4 years for their home purchase.
How Does A GIC Work?
A GIC works by locking in your money for a specified length of time, such as 6 months, 1 year, 18 months, 2 years, 3 years, or even up to 4 years. During this period, the GIC earns a fixed Annual Percentage Yield (APY). This fixed rate provides a predictable return, making it easier to plan your finances as you approach your home-buying goal.
One important feature of GICs is their inflexibility when it comes to early withdrawal; you typically can’t access your money before the GIC matures. However, this lack of liquidity is offset by the safety and stability they offer.
GICs are designed to maintain their value, regardless of market fluctuations, and they are insured by the Canada Deposit Insurance Corporation (CDIC) up to a limit of $100,000. This makes them a very secure investment choice.
GICs: The Recommended Short-Term FHSA Investing Strategy
The real benefit of GICs in the context of an FHSA lies in their customizability. You have the flexibility to shop around for GICs with varying maturities to match your specific timeline. For example, if you’re planning to buy a home in a year, you can opt for a one-year GIC.
If your timeline is three years, you might choose a three-year GIC, or you could create a GIC ladder by purchasing multiple one-year GICs consecutively, especially when you receive new FHSA contribution room each January.
Finally, it’s also wise to look around for promotional rates, as some financial institutions offer particularly attractive terms on their GICs.
FHSA Contribution: Purchasing A House Within 4-10 Years
When your home purchase is planned for a more distant future, typically between 4 to 10 years, your investment strategy within an FHSA should reflect this longer timeframe. While GICs are a safe choice, they may not always be the most effective for longer periods, especially considering the impact of inflation. To balance this, a combination of stocks and bonds can be a more suitable approach.
Stocks: What Are They And Why Should You Invest In Them?
Investing in stocks means buying shares and owning a part of a company. The value of these shares can grow over time, and they might pay dividends, contributing to your investment returns. However, stocks come with inherent risks, as their value can decline if the company or the overall economy performs poorly.
Bonds: What Are They And Why Should You Invest In Them?
Bonds are somewhat akin to riskier GICs. When you invest in bonds, you’re essentially lending money and earning interest in return. Generally, bonds are considered safer than stocks but offer lower returns. Their value can fluctuate with changes in interest rates.
Recommended Long-Term FHSA Investing Strategy
For a 4–10-year investment horizon in an FHSA, a balanced approach might involve a mix of 40% stocks and 60% bonds. This blend offers a combination of growth potential through stocks and stability through bonds.
The simplest way to achieve this balance is through a conservative ETF that holds both stocks and bonds in a single investment vehicle. Investing in such an ETF means you only need to buy and hold one ticker, simplifying your investment process.
A popular example of this kind of ETF is the Vanguard Conservative ETF Portfolio (VCNS). This fund is highly diversified, holding over 13,000 stocks and 18,000 bonds from around the world, and it comes with a management expense ratio (MER) of just 0.24%. For an $8,000 investment in your FHSA, the annual fees would amount to just $19.20.
How To Adapt Your FHSA Contribution Strategy Over Time
As you progress through your journey toward homeownership, it’s crucial to regularly reassess and adjust your investment strategy within your FHSA. This is especially important as your time horizon for purchasing a home gets shorter.
For instance, if you initially invested in a 2-year GIC and are now approaching the time when you plan to buy a home, it might not be practical to reinvest in another GIC. At this stage, shifting your funds into a HISA ETF or even keeping them in cash could be more sensible. These options provide the liquidity and safety needed as you get closer to making that purchase.
Similarly, if you began with a conservative ETF and now find yourself just a year or two away from buying a home, it’s time to consider de-risking. Selling your ETF and moving your investment into a shorter-term GIC can align with your now-reduced time horizon, ensuring your funds are secure and readily accessible when needed.
Remember, the FHSA is a dynamic and flexible tool designed to support your journey to homeownership. Your investment strategy within the FHSA should be equally adaptable. Stay attuned to your home-buying plans and be ready to adjust as necessary.
By keeping a close eye on your investment choices and being proactive about aligning them with your evolving timeline, you can effectively use the FHSA to its fullest potential, paving a smoother path to achieving your dream of owning a home.