Preferred Stock Investing-The Good , The Bad and The In Between 2015 - 2020

[eytonxav]

I think individual preferreds can make sense if you do your homework on what to buy and get them at par value, usually $25/share, otherwise, my advice is stick with the etf versions. Here is a list of etf preferred stocks if you are interested:

Top 9 Preferred Stock ETFs

I held several individual preferred issues during the 2008 collapse and was really concerned at how much value they lost. Also, they can be called and redeemed at par, so you may not realize the income stream you were contemplating and could lose if you paid above par.

[Mulligan]

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Originally Posted by eta2020 So you get 6.5 yield versus PFF ETF 6.05. That is noticeable difference, but I am not sure I would be willing to do my own work to get this difference versus getting ETF. So you are telling me PFF is not tracking S&P U.S. Preferred Stock Index but it buys some other securities? I did not carefully review their prospectus but that looks odd to me.

It says in its prospectus that it "tracks an index" so it can use different ones I assume. But just as importantly the index itself will always change based on calls, new issuances of securities, and size limit. Thus they are forced to buy in some areas high volume crap because they cant buy into small quality issues.
But to me the importance is this. I am damned well not going to give nearly 10% of my yield to an index fund expense ratio, when no research is even being done. Thats crazy to me. However, I put all my stock money into 2 index funds of Total Stock and Total International and do not own individual common stock. Remember you are investing for yield not total return so expense ratios really matter so you have to take that off the top of their claimed yield.


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[Mulligan]

Quote:

Originally Posted by DFW_M5 I think individual preferreds can make sense if you do your homework on what to buy and get them at par value, usually $25/share, otherwise, my advice is stick with the etf versions. Here is a list of etf preferred stocks if you are interested: Top 9 Preferred Stock ETFs I held several individual preferred issues during the 2008 collapse and was really concerned at how much value they lost. Also, they can be called and redeemed at par, so you may not realize the income stream you were contemplating and could lose if you paid above par.

Very true.


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[MooreBonds]

Quote:

Originally Posted by Mulligan Since Moorebonds chimed in I have to personally thank him for steering me this way and showing me the ropes. Though more aggressive than I, he also diversifies better for the risk.

As long as you don't curse me when rates go up and your equity value drops!

Quote:

Originally Posted by Winemaker I purchase no more than $5,000 of each issue, most I purchase in the $22-23 area and purchase 200 shares to diversify. ... Never thought that the GM pensioners would move ahead of me in the succession line and the Freddie Mac issue is still not resolved. Someone is still accumulating those shares for pennies the last time I looked.

That's also my strategy - I typically buy just 100 shares for diversification. If I REALLY feel safe with it (like a few bank issues, a few finance companies), I might buy 200-400 shares total.

however, sometimes I do buy above-par, if the callable date isn't for a few years, and/or if it's a limited term security (i.e. final maturity is defined, so I know the max term I would be locked in for). Because of current rates, I'm willing to buy some Preferreds and baby bonds from mostly BDCs with 3-8 year final maturity terms with yields of about 5%-7%...since it beats the pants off of anything else with that maturity range, gives me a decent income, is somewhat safe (since the BDCs have a high Net Asset Value per share on the common, so plenty of assets to cover the preferreds if it were liquidated), and also reduces my interest rate risk, assuming rates FINALLY move up like everyone is expecting, and allows me to reinvest at a (presumably) higher rate in 3-8 years.

On those Freddie Mac securities, it might just be someone covering a massive short position, since it could be tough to find someone to sell those preferreds. Also, sometimes there is hope when all seems lost. One of my positions that was a bad one was Impac Mortgage Holdings (IMPHP and IMPHO, or formerly IMH Class B and C). It was a mortgage REIT, that floated debt at one rate, and used that debt proceeds to issue mortgages. It got caught with some Alt-A mortgage and other bad loans in 2008, and essentially went just about worthless (common and prefrred).

But there was some value in the ashes, as the preferreds (I own 100 of each class) have slowly risen from under $1/share to currently at about $8-$9. Par is $25. Some have speculated that some of the underlying assets still have value, and that in order for the common stock to start paying dividends again, the preferreds have to start paying. so ther's a chance it could rise back up to $25 and resume the dividend (or get called).

Another preferred had a similar action, when it went to under $1 in the crisis. The common did go bankrupt, and the preferreds eventually got a final cash-out payment of maybe $2.50/share. SO still a loss...but sometimes there is a little value left in a preferred, and everyone stampedes the price down to under $1 as they want to get just anything for it now, versus rolling the dice and seeing what residual value there might be in X years when the dust settles.

[Mulligan]

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Originally Posted by eta2020 For educational purpose can you tell us is the yield taxed at reduced rate just like with regular equities or is some of this taxed at higher income rate (like CDs or Bonds)

Generally speaking the preferreds that pay the low 15% tax are the ones paying out with the retained earnings. The "normal preferreds" if you will. These are the ones that issue the dividends that the company has paid the income tax on. The ones that are taxed as "like CDs or Bonds" are actually in effect "baby bonds" or bank "trust preferreds" just lazily being called preferreds. These are a step higher in bankruptcy claiming. Ticker symbols will not tell you anything. You really need plug the symbol into Quantum to find out which it is.
For example with Exelon (who has various issues), you have BGLEN which pays 15% preferred and BGE-B which does not. I have BGE-B in my Roth.
Winemaker didn't mention this but I am sure he will not mind. He also owns several adjustable rate preferreds which may mitigate loss of capital on interest rate rises, as those are tied into Libor, 3 month, or 10 year treasury rate plus a predetermined amount in addition, with a minimal floor set.


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[eta2020]

I learned one thing here preferred stocks are probably not to my taste....

I rather buy KO, PG, MO, CL, VIG, SCHD, JNJ, PM etc with dividend yield of mostly 2-3% and with a little patience in 10 years I collect 5-6% yield on my investment.

Though they look like good option for someone seeking high immediate income.

[MooreBonds]

Quote:

Originally Posted by eta2020 I learned one thing here preferred stocks are probably not to my taste.... I rather buy KO, PG, MO, CL, VIG, SCHD, JNJ, PM etc with dividend yield of mostly 2-3% and with a little patience in 10 years I collect 5-6% yield on my investment. Though they look like good option for someone seeking high immediate income.

I have the bulk of my portfolio in equities (85%), since I'm only 38. For my fixed income component, the majority is preferreds (7% of total portfolio) and old, higher-yielding I-bonds (5% of total portfolio), with a few other ETFs/Closed End bond funds. I stick mainly with preferreds. I don't view preferreds as a substitute for equities.

Although, as my userID implies, I will be switching to more bonds in the portfolio as I get older and FIRE.

When rates rise up higher, I will divert income from the preferreds and new cash infusions to higher yielding bonds (muni and gov't).

[aja8888]

I have a certain percentage of my tax deferred dividend portfolio in preferreds. I also have a couple of closed end funds that have done very well in that account also. I am in the age group where I am forced to pull RMDs from my tax deferred accounts. The preferreds, dividend stocks, and CEFs replace a fair percentage of the taxable pulls I have to do annually.

My dividend portfolio is about 20% of my tax deferred accounts. The other 80% is in a mix of Vanguard ETFs, short term bond funds, and PenFed 3% CDs.

[Mulligan]

Quote:

Originally Posted by eta2020 I learned one thing here preferred stocks are probably not to my taste.... I rather buy KO, PG, MO, CL, VIG, SCHD, JNJ, PM etc with dividend yield of mostly 2-3% and with a little patience in 10 years I collect 5-6% yield on my investment. Though they look like good option for someone seeking high immediate income.

They definitely should not be considered the "secret investing to riches". Your assessment of yield comparison is a sound one. Articles I have read pegging apples to apples comparisons of common to preferred is about that 10-12 year time frame.
My main reasons for investing in them are different than others who do also, or those that do not at all. Mine basically are 1) investing for high yield income at 15% instead of paying 25% income on lower yielding bonds/CDs.
2) Not a huge common stock investor, needing an illusion of security knowing in they crashed 25% tomorrow in less than 4 years I would make it up in yield while at the same time re-investing the dividends in even higher yields.
3) Security in knowing I get paid in front of common stockholders while knowing history as shown they always pay. 4) Living off a pension instead of my investments allows me to invest to fit my psychological needs, so I don't have to be as aggressive.
A typical non preferred investor such as yourself would probably only be interested in them when some "blood in street crisis" occurs. Back in 2008-09 the smart people bought in on these and made a killing. Many then 7% $25 par bank preferreds went to $7 a share and still are trading. If a person had loaded up on them you would STILL be making 25% a year income on these all while accruing a 300% plus capital gains. Even the economic unaffected electrical utilities were dragged down then. Many are still trading also and you would be collecting 10% plus a year from income and a nice 50% capital gain in your pocket.
I personally wasn't aware or paying attention at the time. But if I had been...


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[Lsbcal]

Just want to make one point here. Preferred stocks have equity characteristics so they are not a substitute for the safety of bonds, particularly in a long recession (or depression). I'm thinking of the average investor who has some AA divided between equities and bonds and cash. I would imagine the preferred's would between between equities and bonds, closer towards equities IMO.

As an illustration of this, here is a plot of a bond index fund (light green) versus a preferred stock ETF (dark green) and and preferred stock fund (orange). Note the dips in 2008-2009 with the preferred's:

[aja8888]

yes, they are certainly not bonds. I think Mulligan mentioned above how they took a beating in 2008-09. But, in good times, when the preferreds are higher than issue price, they can be called, like a bond.

[Mulligan]

Quote:

Originally Posted by Lsbcal Just want to make one point here. Preferred stocks have equity characteristics so they are not a substitute for the safety of bonds, particularly in a long recession (or depression). I'm thinking of the average investor who has some AA divided between equities and bonds and cash. I would imagine the preferred's would between between equities and bonds, closer towards equities IMO. As an illustration of this, here is a plot of a bond index fund (light green) versus a preferred stock ETF (dark green) and and preferred stock fund (orange). Note the dips in 2008-2009 with the preferred's:

All good points, and the confusion of what they are is easy to understand. Vanguard treats them as equity in my "percentage of portfolio" so I am 99% equites by that standard. But if you need to call representatives about preferreds, they will immediately transfer you to the "fixed income department".
Keep in mind about LSB's chart the index crashed very hard in 08-09 because 80% of preferreds are in the financial industry and you know what happened there. If you were in preferreds outside of financials it did not take anywhere close to that fall. In fact ones I now own dropped considerably less than the stock market, and quickly recovered back to near par just a few months later.
Financial experts I have read generally are along your line of thinking recommending no more than 10% allocation.
Traditional age retirees and income investors such as myself obviously may reach for more. The trouble is "preferred stocks" have too many meanings to different people. A recent article from Ken Fisher basically stated they are a whisker away from junk bonds or junk equity and too risky to invest in. Either he has no understanding of the entire preferred market or the admin asst. opined the article. Im sorry, but I don't consider preferred stocks with investment grade ratings from Ameren or Eversource (Northeast Utilities) as anywhere close to junk and 50 plus consecutive years of dividend payments of the issues would tend to support my statement with the type I buy anyways.


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[Winemaker]

Preferreds are a hybrid form of equity shares, issued by a company to raise capital at an agreed upon rate just LIKE A BOND, however, for whatever convoluted reason, possibly to keep debt/equity ratios in balance pay their divvies from earnings/profits.
This qualifies them as a 15% or lower tax rate.


If a trust preferred, these are preferreds backed by a bond pool, that pays interest not really a dividend. These are fully taxed as interest, unless held in a tax deferred account. Banks usually issue these preferred in order to keep capital ratios in line. There has been some question as to whether idiots in Washington would consider them still as tier 1 or 2 capital but if the issues are not considered, the banks would call them at par. I have bought thousands of these shares from various banks at below par and have collected 6+% interest divvies. I don't care if they are called at $25, some issues I paid less than $20.00.


Most concerns I have seen posted are the fact that their value fell during the Great Recession. EVERY ASSET CLASS fell during that time period because no one knew what is or was going on. Pension funds, banks, endowments, insurance companies, charities, hedge funds, and any other type of investor took advantage of obvious facts that a visually impaired person could see ( banks were forced to make mortgages that were to people who couldn't afford them) and bought an speculative hedge (credit default swap) that had too many people sitting on the right (wrong) side of the hedge which as everyone knows turned out pretty $hitty. All investment classes were hit.


I don't understand the thought process that if rates rise, my preferred that I bought for $22.73 that is paying me 6.45% quarterly on par value $25, is going to fall in market value that is now $25.45. It can fall a buck and see if I care. I'm collecting the 6.45% divvie til 2045 unless it goes belly up.


Despite their possible change in value, all my preferred paid their divvies at the fixed rate they agreed to pay, on schedule, and on time, except for the two issues I bought for speculation and not as FIXED INCOME investments.


I am not selling you snake oil, just informing those on this forum of my past experiences with preferreds.

[Lsbcal]

Winemaker, take a look at the chart I posted. The index bond fund (VBMFX, total bond mkt) was pretty stable during the 2008-2009 decline. Treasuries were actually up, one could have been in VFITX (intermediate Treasuries) and done well.

Also, suppose things had gotten worse like in the 1930's. Then being in any kind of equity class would have had a much worse outcome. We have to remember that when the economy is heading south, fear is prevalent and one wants to have some of their assets in relatively safe bonds.

Should we have another decline, my plan is to move my bond funds into Treasuries. Has worked in all postwar recessions that I've got data for.

[Winemaker]

Thanks for bringing that to my attention but was the reason for the stability the fact that when the majority of folks sold out of their falling investments and supply/demand of Treasuries kept pace with the decline? And call me a kook wearing a tin foil hat, but I do not own any Treasuries of any kind unless one of my equity funds or my stable value fund has some. Some day the Treasury is going to run out of other peoples money to buy ink, paper, computers and whatever they need to print Treasuries.




As far as bonds are concerned, I purchased a gang of corporate bonds well, well below par during that time period so I can't explain the bond index being stable. Caterpillar, Humana, General Electric to name a few.

[eytonxav]

Here is an article that explains the dangers and benefits of preferred's pretty well. I think as Mulligan has pointed out, if you decide on individual preferreds, do your homework to understand what you are buying.

Why you should avoid preferred stocks - CBS News

[aja8888]

Quote:

Originally Posted by DFW_M5 Here is an article that explains the dangers and benefits of preferred's pretty well. I think as Mulligan has pointed out, if you decide on individual preferreds, do your homework to understand what you are buying. Why you should avoid preferred stocks - CBS News

Great article. Thanks.

If you are going to buy these stocks, one must pick carefully. I picked up a small position in offerings by U.S. based CHS (CHSCM), a well-run global agricultural cooperative:

Why You Should Prefer Preferreds - Forbes

[Totoro]

A big learning for me here is that when a combination of several factors comes together for the small investor, it can be great:

• Item is callable at any time (either bonds or preferreds)
• Issued by stable companies (like utilities)
• Relatively high interest rates (typically older issues)
• Long maturities (even "infinite"?)
• .. and also: a small portion of the total market

All these mean a relatively sure thing. The fact that the market is niche and callable at any time mean there's a natural upper limit on price.



From a company perspective since this type of debt is junior to regular bonds actually calling them is a bit of a hassle, and marginal in their total financing anyway. So unless the rates diverge very much, it's not really worth calling.



Just need to find ones around par (as mentioned here). Not sure how I would go about finding euro denoted ones though (+non-financial)

[Mulligan]

Totoro you need a European version of Quantumonline if there is one. I have no familiarity in that realm though. I know some European banks such as RBS and Lloyds have them but they are in the US market though. The ones that I found to be my liking I would enter common stock ticker symbol into Quantumonline. Then I would hit related securities under company. There is would pop out the whole list and I would read and compare them.


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[Winemaker]

Check out www.dividendyieldbusters.com/preferred-stocks-trading-under-par. There are numerous stocks given as well as various income portfolios using preferreds as well as last years model portfolio . You can just get an idea of how to use preferreds to your advantage.


I didn't see any great boogiemen that were not already discussed about preferreds in that CBS article.


Mulligan and I have had several conversations on the side about preferreds and he warned me about forum members having great fear of these investments. I believe Buffett has said (paraphrasing)" Buy when others are fearful and sell when others are greedy".