TFSA Investors: Don’t Chase Yield — Do This Instead

When it comes to building passive income in your Tax-Free Savings Account (TFSA), it’s easy to get caught up chasing the highest yields you can find.

The higher the yield, the more of a return you can begin to earn right away. So, when you see a stock offering an 8% yield, or even higher, and often trading cheaply as well, it can seem like the perfect undervalued stock to buy for your TFSA.

But in reality, that’s where a lot of investors get themselves into trouble, because more often than not, when a stock offers a really high yield, it’s not because it’s a hidden opportunity. It’s because the market expects something to go wrong and has already sold the stock off significantly, which sent the dividend yield soaring.

Either the business is under pressure, cash flow isn’t as strong as it appears, or there’s a real risk that the dividend will be cut in the coming months.

And in a TFSA, that sustainability matters even more because if you buy a risky, high-yield stock that ends up dropping significantly and you sell at a loss, that contribution room is gone for good.

Instead of chasing yield, the better approach is to focus on total return over the long haul and the quality of the income you’re generating in your TFSA.

Why yield alone doesn’t tell the full story

A high yield might look attractive on the surface, but it doesn’t mean much if the stock price is falling or the dividend isn’t sustainable.

In fact, a stock yielding 4% that can grow earnings and increase its dividend over time will almost always outperform a stock yielding 10% that’s shrinking or struggling.

That’s why it’s so important to look beyond the yield and understand how the business actually generates cash.

For many companies, the most important figure is cash flow, and sometimes, with specific companies, such as pipeline operators, one of the most important metrics is distributable cash flow or funds from operations (FFO).

Those numbers give you a much better picture of how sustainable the dividend really is because they focus on the actual cash coming in rather than accounting earnings.

And that matters, because earnings can be distorted by non-cash expenses like depreciation, which can make a perfectly safe dividend look riskier than it actually is.

So, if you’re building a TFSA for long-term income, the goal shouldn’t be fully focused on trying to maximize yield today; it should be more about finding reliable businesses that can continue paying and growing that income over time.

Focus on the quality of the income in your TFSA

There’s no question that the main focus for dividend investors should be to build their TFSA with a mix of high-quality income investments rather than just chasing the highest yield they can find.

For example, South Bow (TSX:SOBO) is one of the more attractive higher-yield options right now.

It owns critical pipeline infrastructure, and much of its revenue is backed by long-term contracts. That means it acts more like a toll booth than a traditional energy company, generating steady and predictable cash flow.

Even though the yield is relatively high, the underlying business is stable, and when you look at its cash flow rather than just earnings, the payout is much more sustainable than it might initially appear.

In fact, for 2026, South Bow expects its payout ratio to be just 64%. And when you consider it offers an attractive yield of 5.9% today, it’s certainly a company you can have confidence owning for years.

On the other hand, a stock like Granite REIT (TSX:GRT.UN), owns industrial real estate like warehouses and logistics centres, which are essential for e-commerce and global supply chains.

The yield is slightly lower, at roughly 4.2%, but the business is extremely stable, with high occupancy and strong demand for its properties.

Furthermore, it’s consistently increasing its distribution each year as its FFO grows with rising rents and new properties being acquired.

That’s the type of balance you want, stocks that offer reasonable yields but still have the potential and flexibility to continue growing their operations and distributions over time.

Because at the end of the day, the goal of your TFSA isn’t just to generate income today, it’s to build a portfolio that continues growing and increasing your income over time.

The post TFSA Investors: Don’t Chase Yield — Do This Instead appeared first on The Motley Fool Canada.

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More reading

• The Very Best Canadian Stocks to Hold Forever in a TFSA
• My 3 Favourite Stocks for Monthly Passive Income
• $50K TFSA: How to Structure for Constant Income
• Safer Dividend Stocks to Buy With $20,000 Right Now
• 4 TSX Dividend Champions Every Retiree Should Consider

Fool contributor Daniel Da Costa has no position in any of the stocks mentioned. The Motley Fool recommends Granite Real Estate Investment Trust. The Motley Fool has a disclosure policy.