Preferred shares: a hybrid option

| August 11, 2023

With a potential decrease in interest rates in the coming months, an intriguing investment opportunity might be preferred shares of stock. This class of stock isn’t discussed much, maybe because they aren’t widely issued. But they combine properties of stocks and bonds and can be an option for diversifying your portfolio.

Preferred shares trade like common shares, with their own ticker symbol, on stock exchanges. But they really behave more like bonds. They generally pay a fixed, regular dividend that’s higher than what you’d get from a common share. But unlike bonds, which have a defined term when they’re issued, preferreds can remain outstanding for an indefinite period. Companies can “call,” or repurchase, preferreds if they wish, however.

Preferred shares have priority over common shares with respect to dividends, but you’re sacrificing the unlimited potential gains in price that you get with common shares. Preferred shares tend to trade in a narrower price band because of the higher dividend payouts that are more secure than common stock dividends.

On the other hand, preferreds are generally riskier than bonds. The main reason preferreds carry more risk than bonds is that companies are obligated to pay bond interest before they pay preferred dividends. Companies can also postpone or perhaps even skip preferred dividend payments. (Meanwhile, it’s fairly common for companies to suspend dividend payments of common shares in difficult economic times.)

What makes preferred shares a more interesting option today is that like bonds, they tend to have an inverse relationship with interest rates. Nobody’s making any promises, but with inflation continuing to moderate, there’s a chance of lower interest rates benefiting preferred shares to a limited degree.

Now, most issuers of preferred shares are financial institutions such as insurance companies, banks, and real estate investment trusts. And as you’ll remember, earlier this year the banking industry went through a shaky period. Banks aren’t out of the woods yet, but it seems as though the damage has been limited.

So if you’re interested in preferred shares, I suggest starting with a focus on larger, more financially secure banks and other institutions. Review their Moody’s or S&P credit rating, as you would a corporate bond.

You might find several different offerings of preferreds from the same issuer but with different yields. And each preferred share will have a different ticker symbol.

Another wrinkle with preferred shares is that some issues can be converted into a specified number of shares of common stock. As you might have inferred, make sure you understand the terms and conditions for any preferred shares of interest, because they come in different flavors.

You might find it easier to participate in preferred shares via a mutual fund or exchange-traded fund. A total preferred-share fund might be a good place to start if you want to add a hybrid equity that provides some of the features of a bond with those of a stock.

Sources

https://www.nerdwallet.com/article/investing/what-is-preferred-stock

https://www.spglobal.com/spdji/en/documents/research/research-digging-deeper-into-the-us-preferred-market.pdf



Evan R. Guido is the Founder of Aksala Wealth Advisors LLC, a 2018 Forbes Next-Gen Advisors List Member, and Financial Professional at Avantax Investment ServicesSM. Evan heads a team of retirement transition strategists for clients who consider themselves the “Millionaire Next Door.” He can be reached at 941-500-5122 or eguido@aksalawealth.com.   Read more of his insights at https://finance.heraldtribune.com/category/ask-guido/. Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC.  Investment advisory services offered through Avantax Advisory ServicesSM, Insurance services offered through  an Avantax affiliated insurance agency.  6260 Lake Osprey Dr. Lakewood Ranch, FL 34240.  The views and opinions presented in this article are those of Evan R. Guido and not of Avantax Wealth Management® or its subsidiaries.  Past performance does not guarantee future results. The S&P 500 is an index of 500 major, large-cap U.S. corporations. Standard & Poor's is a corporation that rates stocks and corporate and municipal bonds according to risk profiles. The S&P 500 is an index of 500 major, large-cap U.S. corporations. You cannot invest directly in an index.  An investment in a money market fund is not insured or guaranteed by the FDIC or any other government agency.  Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.  CDs are FDIC insured and offer a fixed rate of return.  They do not necessarily protect against a rising cost of living.  The FDIC insurance on CDs applies in case of insolvency of the bank, but does not protect market value.  Other investments are not insured and their principal and yield may fluctuate with market conditions. Investments are subject to market risks including the potential loss of principal invested.  Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.  In general, bond prices rise when interest rates fall, and vice versa.  This effect is usually more pronounced for longer-term securities.  You may have a gain or loss if you sell a bond prior to its maturity date.  Exchange-traded funds (ETFs), as the name implies, are funds that trade like stocks. A single ETF often attempts to mirror an entire index such as the S&P 500, Dow Jones Industrial Average, or Nasdaq Composite Index; an entire sector of the equities market such as large caps, small caps, growth stocks or value stocks; or whole industries such as technology, energy or biotechnology. In addition, specialized ETFs can cover market niches such as gold, precious metals or REITs, and they can even cover other asset classes like fixed income.  Investments that are concentrated in a specific region, sector or industry may be subject to a higher degree of market risk than investments that are more diversified.  ETFs are traded like stocks or bonds and offer liquidity throughout the day as opposed to the end-of-day pricing system for mutual funds.