Preferred stocks represent ownership in a company and trade on exchanges like common stocks. But preferreds are also a lot like bonds — many pay fixed dividends, and their share prices are sensitive to an issuer’s creditworthiness and interest-rate fluctuations, notes Richard Moroney, editor of Dow Theory Forecasts.
Most investors in preferreds are attracted to their generous yields. The S&P U.S. Preferred Index, which has nearly 300 holdings, yields about 6.1%, compared to 2.0% for the S&P 500 Index.
Many preferreds generate qualified dividend income taxed at rates up to 20%. Preferred investors take a back seat to bondholders if a company declares bankruptcy.
There are other reasons to consider preferreds. They tend to be less volatile than common stocks. The S&P U.S. preferred index has a standard deviation of 4.3% based on 60 months of returns ended February, versus 10.2% for the S&P 500.
Preferreds can help diversify a portfolio of common stocks. Only 32% of the return of the preferred index is explained by movements in the S&P 500.
The table below lists five exchange-traded funds (ETFs):
First Trust Preferred & Income (FPE) — yielding 5.7%
iShares U.S. Preferred (PFF) — yielding 5.8%
PowerShares Fin’l Preferred (PGF) — yielding 5.7%
PowerShares Preferred (PGX) — yielding 5.8%
VanEck Vectors Preferred Ex-Financials (PFXF) — yielding 5.8%
iShares S&P U.S. Preferred Stock, which tracks the S&P index, is a good all-weather pick. The second-oldest and largest preferred ETF, with assets of $17.0 billion, the fund is invested roughly 72% in financials and 11% in real estate. The ETF has a five-year annualized return of 6.0%.
