Advertisement
investing

Earn Dividends From Preferred Stocks

Yields are superb, but these investments are riskier and more complex than you may think.

Does a 7.3% yield whet your income-starved appetite? That's what the average preferred stock currently pays. Tempting, for sure. But don't jump into these quirky securities before you understand their ins and outs.

Preferreds pay fixed dividends. That makes them similar to bonds, which usually pay a set amount of interest. When it comes to paying dividends, preferred investors get preference over holders of common stock. A firm must ax common-stock dividends before it tampers with preferred payouts. Preferred holders also get preference over common holders in the event a company liquidates, though bondholders get first dibs on the firm's assets.

Advertisement - Article continues below

Preferreds generally yield more than a company's common stock and sometimes yield more than the firm's bonds. In addition, dividends from some preferred stocks are qualified, meaning that they are taxed at a top federal tax rate of 15%. (Nonqualified dividends are taxed at a maximum federal rate of 35%. It's best to use nonqualified preferreds inside of tax-deferred accounts, such as IRAs.)

Preferreds are less risky than common stocks but offer less opportunity for appreciation. Ignore preferreds' spectacular climb from March 2009 through March 2010. During that period, iShares S&P U.S. Preferred Stock Index (symbol PFF), an exchange-traded fund that tracks an index of more than 220 issues, soared 181%. The surge followed an equally stunning flameout during the financial crisis.

Advertisement
Advertisement - Article continues below

A replay of the 2008-09 cataclysm isn't likely anytime soon. The bigger risk to preferred values today is rising inflation and interest rates. Because preferreds pay fixed dividends, higher rates could force down preferred share prices. "Preferreds really start to fall apart when inflation hits," says Ken Winans, president of Winans International, a Novato, Cal., investment firm.

Advertisement - Article continues below

Preferreds don't have fixed maturity dates, but most may be redeemed by their issuers. Before buying a preferred, find out when it can be called and at what price. If the call price is below the current price, you could lose principal if the stock is redeemed. Note, too, that most preferred issuers are in the financial sector; more than 80% of the iShares ETF's assets are in preferreds issued by financial firms.

Of the six preferreds listed in the table below, only one is issued by a financial company. Don't be surprised by the so-so Standard & Poor's quality ratings, which are at the low end of investment grade for five of the issues and in junk territory for Ford. The preferred rating is usually a level or two below a company's bond rating.

In the end, the iShares ETF may be the best choice for most investors, even though it distributes a mix of qualified and nonqualified dividends. From its launch in March 2007 through February 11, it returned an annualized 1.9%, a figure that includes a 23.8% loss in 2008. Over the past year, the ETF gained 13.8%. The fund, which charges annual fees of 0.48%, yields 6.5%.

Advertisement
Advertisement

Most Popular

7 Surprisingly Valuable Assets for a Happy Retirement
happy retirement

7 Surprisingly Valuable Assets for a Happy Retirement

If you want a long and fulfilling retirement, you need more than money. Here are the most valuable retirement assets to have (besides money), and how …
August 3, 2020
Turning 60 in 2020? Expect Lower Social Security Benefits
Coronavirus and Your Money

Turning 60 in 2020? Expect Lower Social Security Benefits

When you file for Social Security, the amount you receive may be lower.
July 30, 2020
How a Second Stimulus Check Could Differ from Your First One
Tax Breaks

How a Second Stimulus Check Could Differ from Your First One

The HEROES Act, which was passed by the House in May, would authorize a second round of stimulus checks. While the new payments would be similar to th…
July 22, 2020

Recommended

Bonds: 10 Things You Need to Know
Investing for Income

Bonds: 10 Things You Need to Know

Bonds can be more complex than stocks, but it's not hard to become a knowledgeable fixed-income investor.
July 22, 2020
13 Dividend Stocks That Have Paid Investors for 100+ Years
stocks

13 Dividend Stocks That Have Paid Investors for 100+ Years

Here are 13 dividend stocks that each boast a rich history of uninterrupted payouts to shareholders that stretch back at least a century.
May 21, 2020
20 Dividend Stocks to Fund 20 Years of Retirement
dividend stocks

20 Dividend Stocks to Fund 20 Years of Retirement

Each of these high-quality dividend stocks yields roughly 4%, and you can expect them to grow their payouts even more. That's a powerful 1-2 combo for…
August 5, 2020
10 Best Stocks to Buy If President Donald Trump Wins Re-Election
stocks to buy

10 Best Stocks to Buy If President Donald Trump Wins Re-Election

The 2020 election likely will be a pivot point for several areas of the market. Here are some of the best stocks to own should President Donald Trump …
August 4, 2020