Asset Focus: Preferred Stock

Investing in preferred stocks can be a great to add monthly income to your investment portfolio or retirement account. But are these crossover debt/equity assets right for you? Well, you need wonder no more. Here is our quick one stop guide to investing in preferred stocks.

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What Are Preferred Stocks?

Issuing preferred stocks is a way for companies to raise cash from investors on preferred terms. Some companies issue them to finance specific projects. Other companies may issue preferred stock because they are unable to issue any more debt at decent rates. Either way, preferred stock is an equity investment that acts a little bit like debt.

While the individual terms of each issue of this type of stock is different, the main thing to note is that preferred stockholders have a “1st dibs” claim over the dividend distributions the issuing company. Also, the dividend distributions attached to preferred stock are generally higher than that of common stock.

Preferred stocks act a bit like debt and equity, giving investors a priority claim over a company's income and assets

Preferred stock investors also have a priority claim ahead of common stockholders when it comes to the distribution of assets if the company is liquidated. That said, bondholders still get 1st priority in such a situation, and preferred stocks usually also have no voting rights when it comes to the running of the company.

The combination of priority income distribution and an enhanced claim over a companies assets during a liquidation makes preferred stocks a popular investment with conservative income-focussed investors.

Preferred Stock Dividends

While the terms of each individual issue are different, most preferred stocks will enjoy some form of priority dividend distribution. Preferred stock dividends are often paid monthly or quarterly, and can be a fixed amount per share, or set against a benchmark interest rate such as the LIBOR.

Preferred shares usually have a higher yield than common stock

Preferred Stock Calls

Sometimes, preferred stocks are callable. This means the company can buy back the preferred stock at par value after a predetermined date. For example, if interest rates fall, and the issue of preferred stock now looks expensive with its high yield, the company can call the stock and reissue another series of preferred stock with a lower dividend yield.

Convertibility of Preferred Stocks

Preferred stock is also sometimes convertible. This means that preferred stocks shares can be traded for common stock if certain conditions are met. For example, the preferred stockholder could have the option to convert. So too might the company’s executive management. in some cases, preferred stock might convert to common stock automatically at a set date.

How to Invest in Preferred Stocks

A lot of preferred stock issues are taken up by institutional investors. These big bulk-buyers often enjoy certain tax breaks for investing in this type of stock that are not available to individual investors. That said, there are plenty of ways you can add preferred stocks to your investment portfolio or retirement account.

You can invest in individual preferred stocks or via exchange traded funds

List of Preferred Stock ETFs

You can invest in individual preferred stocks, or via a managed investment fund such as an exchange traded fund (ETF). Here is my list of 10 highly-rated preferred stock ETFs available at the time of writing (August, 2021):

  1. iShares Preferred and Income Securities ETF – PFF
  2. Invesco Preferred ETF – PGX
  3. First Trust Preferred Securities and Income ETF – FPE
  4. Global X U.S. Preferred ETF – PFFD
  5. Invesco Financial Preferred ETF – PGF
  6. VanEck Vectors Preferred Securities ex Financials ETF – PFXF
  7. Virtus InfraCap U.S. Preferred Stock ETF – PFFA
  8. iShares International Preferred Stock ETF  – IPFF
  9. InfraCap REIT Preferred ETF – PFFR
  10. SPDR Wells Fargo Preferred Stock ETF – PSK

To keep up to date with this list and other individual stocks, mutual funds and ETFs that pay monthly dividends, you can download the complete suite of lists and subscribe to our FREE Priority Investor email for regular updates using the form below.

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Investment Returns for Preferred Stocks

The primary return on investment for preferred stockholders in yield. And because preferred stock dividends are often distributed monthly or quarterly, this kind of stock is often popular with investors seeking to boost their monthly income.

This type of stock generally doesn’t appreciate in value in the same way as regular common stock. Preferred stock usually trades close to its issue price, and any premium or discount in the pricing depends on the quality of the issuing company and the specific terms of the stock issue.

Preferred stocks pay bigger dividends but tend to trade close to their original issue price

Most private investors will invest in preferred stocks via a managed fund such as an ETF. Many of these funds have done quite well through 2021. For example, the iShares International Preferred Stock ETF from the list above has delivered a year to date return of 11.80% in August, 2021. This particular ETF has delivered a trailing 1-year total return of 42.93%.

Are Preferred Stocks Risky?

Stocks can be quite a risky investment in general, and preferred stocks are no different. In the same way as as stock, the risk attached to any particular preferred stock of fund is dictated by the quality of the issuing company and the specific terms of the stock issue(s).

One of the main areas of concern for preferred stock investors is interest rates. Because preferred shares are basically an issue of debt, their value can be impacted by changes in interest rates. If interest rates go up, these types of stocks look less attractive and their value can fall. Likewise, is interest rates fall, investors seek out better returns elsewhere, and the popularity (and value of preferred tends to rise.

The value of preferred shares can rise and fall with interest rates

Another consideration for preferred stock investors is call risk. There is always the possibility that the issuing company can call an issue of preferred stock, effectively buying it back from shareholders if suits the business and circumstances at the time.

As with any investment, diversification is key. You should not invest an amount in any one investment that you cannot afford to lose. While every investors circumstances are different, royalty income trusts usually make up only a small part of a diversified investment portfolio.

Conclusion and Resources

Informed investors make better decisions. If you want to learn more about preferred stocks, you can further your research using the following resources: