While technically a stock, preferreds act more like bonds than they do stocks. In the hierarchy of safety, they are secondary to a corporation's bonds, but senior to the common stock of a company. Preferred Stocks1 typically offer higher yields than money market funds2, CDs3, U.S. Treasuries4, and corporate bonds5.
The chart below clearly illustrates how your money can grow at various interest rates, and the potential impact a rate of return can have on your fixed income portfolio over time.
There are basically 3 types of Preferred Stocks: Straight Preferred Stocks, Floating Rate Preferred Stocks, and Convertible Preferred Stocks.
1) Convertible Preferred Stocks: Convertible Preferreds typically act more like stocks than they do like bonds. For that reason, I would place convertibles on the equity/stock side of the Asset Allocation Model. They tend to have about 60-80% of the movement or volatility of the underlying common on any given day, often pay a higher dividend than the underlying common stock, but typically have a lower yield than that securities' Straight Preferred Stock.
2) Floating Rate Preferred Stocks: Floating Rate Preferred Stocks often are issued with a fixed interest rate for say the first 5 years, after which time the interest rate begins to 'float' or reset periodically with the movement of interest rates up and down. They can be a hedge against rising interest rates, but typically have lower rates than new issue fixed preferreds. Accepting a lower current interest rate is what you basically give up for that hedge.
3) Straight Preferred Stocks: Of the 3 types of Preferred Stocks, I prefer to use Straight Preferreds in my clients' fixed income allocations. As I mentioned, straight preferreds act more like bonds than stocks. Unlike common stocks, Straight Preferreds have a stated coupon or interest rate that does not change over the life of the preferred.
They typically are issued with 5 year call protection, after which time they can be called at any time by the issuer. Most are perpetual, with no maturity, but some have specific maturities, typically 30 to 50, or even 100 years in the future. When we meet, I'll explain why those long maturities are virtually immaterial when considering high coupon Straight Preferred Stocks.
Often preferreds are rated by the credit rating services as are bonds. Over 90% of Straight Preferred Stocks are issued in $25 denominations and have daily liquidity, as they are listed on the exchanges and traded like stocks. Some preferreds are issued in $10, $50, $100 and even $1,000 denominations. Most Straight Preferred Stocks pay quarterly dividends, but more and more new issue preferreds are beginning to pay their dividends monthly.
Most preferreds typically trade with low daily volumes, as investors usually hold preferreds to collect or reinvest the dividends, and don't buy them to trade. Their daily volatility is more in line with interest rates, and not the general stock market. They, however, typically move very little daily and typically are disconnected from the daily fluctuations of the short or intermediate term treasuries.
I typically review a long list of over 900 preferreds several times a year searching for attractive opportunities for my clients. Currently, I am predominately purchasing Straight Preferred Stocks with yields above CDs and U.S. Treasuries.
If you currently have money you hold in low yielding money market funds, 0% interest checking accounts, or lower yielding CDs, and U.S. Treasuries, and you own no Preferred Stocks, we definitely need to talk.
In summary, Preferred Stocks represent a good alternative higher yielding investment choice for both growing a portfolio toward retirement, and living off reliable, or durable income in retirement. Please give me a call to schedule an appointment to further talk about Preferred Stocks, and the advantages they can potentially offer your fixed income portfolio.
1 Preferred stocks are not insured. Preferred stocks may be called away early, subject to the terms of their call covenants as stated when issued. Any fees may reduce the amount you earn. Preferred stocks may move up and down in value subject to changes in credit ratings, interest rates, and perceived or real financial conditions of the underlying company. Upon maturity, you may not be able to reinvest your principal at the same or higher interest rate. Preferred stocks are subject to federal income tax, and may be subject to state and local taxes also.
2 An investment in money market funds is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in these funds. Money market funds typically provide daily liquidity. Internal costs and expenses will vary among funds. Some money market funds may be taxable, while others investing in federally tax free municipal bonds may be free of federal income tax.
3 CDs or certificates of deposit are FDIC insured, guaranteed by the Federal Deposit Insurance Corporation for up to $250,000 per depositor, per insured bank, for each ownership category. Any fees may reduce the amount you earn. CDs may be subject to early withdrawal penalties. CDs may be subject to fluctuations in value as interest rates move up and down, but if held to maturity, FDIC insured CDs will return your original principal plus the stated interest. Upon maturity, you may not be able to invest at the same or higher interest rate. CDs are subject to federal income tax, and may be subject to local or state taxes also.
4 U.S. Treasuries are backed by the full faith and credit of the United States government. Any fees may reduce the amount you earn. U.S. Treasuries are subject to fluctuations in value as interest rates move up and down, but if held to maturity, treasuries will return your original principal plus the stated interest. Upon maturity, you may not be able to reinvest your principal at the same or higher interest rate. U.S. Treasuries are subject to federal income tax, and may be subject to state and local taxes also.
5 Corporate bonds are typically not insured. Corporate bonds may be called away early subject to the terms of their call covenants as stated when issued. Corporate bonds may move up and down in value subject to changes in credit ratings, interest rates, and perceived or real financial conditions of the underlying company. Upon maturity, you may not be able to reinvest your principal at the same or higher interest rate. Corporate bonds are subject to federal income tax, and may be subject to state and local taxes also.