Preferred Stocks
A preferred stock is a hybrid security, a cross between a stock and a bond. It pays a dividend that is typically lower than a bond’s interest payments, but higher than the common stock’s dividend. This fixed amount has a higher corporate priority than payment of common stock dividends, but the board of directors can always decide to lower or eliminate the preferred dividend—unlike the corporate promise behind bond interest payments.
Preferreds can have large price swings, somewhat similar to what common stocks experience. The typical preferred is issued by a highly indebted company that needs cash; the most common issuers are banks and other financial institutions, telecoms, and utilities. As a general rule, up to 10% of the fixed-income portion of a portfolio could be in preferreds. There are a modest number of mutual funds and ETFs that specialize in preferred stocks.
Preferred ETFs
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Cohen & Steers Preferred Securities… (CPXAX) |
PowerShares Preferred (PGF) |
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iShares S&P U.S. Preferred Stock Index (PFF) |
Principal Preferred (PPSAX) |
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PowerShares Financial Preferred (PGF) |
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Many preferreds have qualified dividends (lower tax rate for investors); other preferreds are trust-preferred stock issued by banks that do not qualify for the lower tax rates (but benefit the bank because the “dividend” is considered a deductible interest expense). By 2016, banks will no longer be able to issue or use trust-preferred stock.