Many of the clients who come to us at SAM are looking to build a retirement portfolio that generates a steady stream of income. They don’t want an all-stock portfolio — too risky. An all-bond portfolio doesn’t yield enough for their needs. And the “tried-and-true” 60/40 blend has proven to be riskier than many realized was possible.
Fortunately, we have another choice on the menu. Preferred stocks have a reputation for generating a higher return than most bonds while being less risky than common stocks.
Positioned between common stocks and bonds, preferred stocks offer a unique combination of benefits that can enhance an income portfolio. Here are three compelling reasons why SAM believes investors should consider a strategy that utilizes preferred stocks for their retirement portfolio.
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1. Attractive yields
One of the most significant advantages of preferred stocks is their ability to offer attractive yields compared to other income-producing assets like bonds or dividend-paying common stocks. Preferred stocks typically pay fixed dividends, much like bonds, and these dividends are often higher than the yields on bonds of similar credit quality.
For income-focused investors, the higher yields from preferred stocks can be a crucial component of a diversified portfolio. These yields provide a reliable income stream that can help meet financial goals, whether it’s covering living expenses, funding retirement or reinvesting for growth. The fixed dividend payments also offer a degree of predictability, making it easier for investors to plan their cash flows.
2. Priority over common stock dividend payments
Another compelling reason to invest in preferred stocks is their priority in dividend payments. Preferred shareholders are entitled to receive dividends before common shareholders. This means that in times of financial stress, when a company might reduce or suspend dividends on common stock, preferred shareholders are more likely to continue receiving their dividends.
Additionally, many preferred stocks come with a “cumulative” feature, which means that if a company is unable to pay dividends in any period, the unpaid dividends accumulate and must be paid out to preferred shareholders before any dividends can be distributed to common shareholders. This cumulative feature provides an extra layer of security, making preferred stocks an attractive option for conservative income investors who prioritize stability and consistency in their income stream.
3. Potential for capital appreciation
While preferred stocks are primarily income-generating instruments, they also offer some potential for capital appreciation, making them a versatile addition to an income portfolio. Unlike bonds, which generally have a fixed maturity date and return principal at par value, preferred stocks can trade on the open market, and their prices can fluctuate based on various factors, including interest rates, credit quality and overall market conditions.
When interest rates decline, the price of preferred stocks that have fixed dividend payments often rises. That’s because their fixed dividends become more attractive relative to new, lower-yielding investments. As asset managers, this can provide us with an opportunity to realize capital gains for our clients in addition to the income generated from dividends. Moreover, during periods of economic recovery or improving corporate profitability, preferred stocks issued by financially strong companies can appreciate in value, offering the potential for a double benefit of both income and growth.
It’s important to note, however, that while preferred stocks can appreciate in value, they also carry some risk of price volatility. Therefore, they should be considered as part of a diversified portfolio, where the potential for capital appreciation can be balanced against the stability of other income-generating assets.
Preferred stocks offer a compelling blend of high yields, dividend payment priority and the potential for capital appreciation, making them a valuable addition to most retirement portfolios. We utilize these characteristics to help investors achieve a balanced approach to income generation, providing both stability and the opportunity for growth.
However, as with any investment, it’s important to understand the risks associated with preferred stocks, including interest rate sensitivity and the potential for price volatility. At SAM, we carefully select preferred stocks by focusing on issuers with strong credit ratings and stable financials. High yields can be great, but it is important to also mitigate risk and enhance the overall resilience of any retirement portfolio.
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