High Yielding Alternatives: Preferred Stocks an Easy Solution.

Although “preferred stocks” may be a great investment option for income, the word “stock” is the name is often misleading. Although these “stocks” can trade on the major exchanges, they are primarily fixed-income investments, with many investors use Preferreds as CD alternatives. The dividend payments for preferred stocks are set when the shares are issued and generally do not vary with most of them become callable five years after they were issued. This means that if interest rates fall, a company can take back the shares and pay you at the price at which they were issued.

Many analysts agree that one of the positives of Preferreds has been their relatively stable share price. That stability comes from knowing the level of future dividends, so long as the companies continue to meet all of their debt obligations, whereas with common stock, by contrast, companies can cut dividends during lean times without any warning. Generally, Preferreds are susceptible to the same risk factors as bonds, like inflation and rising interest rates. For the most part, if a company misses earnings estimates, that might affect the common stock, but not the Preferreds. However, if there is something serious that would affect the creditworthiness of a company, like a downgrade, that could hurt its preferred shares.

For the Individual investor, Preferreds are easier to own than individual bonds.  Preferreds can be bought and sold on the major exchanges, rather than in the bond market, which is less liquid and transparent. And shares are usually priced at $25 each when they are issued, versus the $1,000 price for most new corporate bonds.

For tax purposes, there are two flavors of preferred stocks.  Many preferreds have dividends that are eligible for the qualified dividend tax rate—15 percent for most investors—because the dividends are paid with after-tax dollars, while others pay dividends that are taxed at an investor’s federal income tax rate.  The companies write off these payments, so from the perspective of the IRS, they are more like the interest that is paid to corporate bondholders.

Generally, the preferreds that do not pay qualified dividends yield a bit more than those that do, so put those into tax advantaged accounts like IRA’s. However, if the dividend is high enough even after you pay the taxes, as is often the case, a non-retirement account is just fine. If you are buying an individual security, the prospectus will say whether it pays qualified dividends.

Preferred stocks can be a great addition to your portfolio, whether you are looking to get a higher yield than CD’s or money markets, or to provide stability to your portfolio in a volatile market.

Keith W. Springer is Registered Investment Advisor and President of Capital Financial Advisory Services, providing Wealth Management and Mortgage Consulting Services.  For more information on how to build and maintain a solid retirement plan, please contact Keith Springer at 916-925-8900 or keith@capfas.com