Why Preferred Stocks Don’t Make Good Bond Substitutes

preferred stock etfs pros and cons

Alternatively, it can be just as hard to decide what to do when some investments are up significantly, causin… With that said, for those looking to buy preferred shares individually, be aware that there are some other important factors to consider. Preferred stocks come with maturities, which tend to be very long. True, some preferred stocks are perpetual, meaning they preferred stock etfs pros and cons never mature, but maturities of 30 years or longer are typical. Bond ETFs can offer competitive long-term returns regardless of the movements of the stock markets. Speculative-grade investments, with ratings from BBB- through B-, account for 69.8% of the fund’s holdings, and 4.4% were unrated. This ETF tracks the performance of the S&P U.S. Preferred Stock Index.

preferred stock etfs pros and cons

If you prefer to have a larger allocation to U.S. stocks, for example, you might want two separate stock ETFs. Wells Fargo and Company and its Affiliates do not provide tax or legal advice. Please consult your tax and legal advisors to determine how this information may apply to your own situation.

General Risks

This content is not provided or commissioned by the bank advertiser. Opinions expressed here are author’s alone, not those of the bank advertiser, and have not been reviewed, approved or otherwise endorsed by the bank advertiser. This site may be compensated through the bank advertiser Affiliate Program. Kevin Mercadante is a former mortgage loan officer and blogger behind Out of Your Rut. He is an expert in mortgages, career strategies and retirement planning.

The second chart in this section shows the one-year total return on PFF when the purchase was made under different yield spread. As can be clearly seen, first that is a positive trend, indicating that the odds and amount of the total return increases as the yield spread increases. Particularly as shown in the green box, when the spread is about 4.5% or higher, the total returns in the next one year are all positive and sometimes very large (the highest https://online-accounting.net/ return was about 27%). I am bullish in terms of its income potential and the opportunity to generate extra alpha due to its low correlation to my other holdings. The expense ratio of PFFD is only 0.23%, while the average preferred stock ETF expense ratio is 0.55%. Learn how much money you need, how to get started, and common pitfalls to avoid. Simply put, anyone considering buying preferred stock needs to be willing to do a lot of homework.

Top 5 mistakes of ETF investing

Let’s review a C-corp preferred share as an example of some of factors investors need to understand. However, the point is that for most preferred dividends you get taxed at much lower rates than you would with bond interest payments. The exception is municipal bonds which are tax free at the Federal level and tax free at the state level if you live in the state that issues them. That’s because inflation eats away at the value of a bond’s interest payments, reducing their inflation-adjusted or “real” returns. The longer the duration of a bond , the more sensitive it is to interest rate fluctuations.

  • In my most recent article for Seeking Alpha, I set out to examine three of the most popular preferred stock ETFs and determine which, if any, would be the next purchase for my portfolio.
  • For example, the 30-year bond might yield 4 percent when the one-year bill yields 1 percent.
  • Preferred stock doesn’t offer the capital appreciation potential of common stock.
  • If one or more of those agencies were to downgrade the rating on the preferred stock, the value can drop.
  • Information is provided ‘as is’ and solely for informational purposes, not for trading purposes or advice, and is delayed.

There are generally no managers involved, so these funds have lower fees and let you trade easily and frequently. While most investors buy and sell what is known as common stock, there’s also something called preferred stock. For the most part, it comes down to what your goals are—and your preferences. As a general rule, ETFs provide excellent diversification at a low ongoing expense ratio since many are passive funds that track a certain benchmark index.

What Are the Disadvantages of Owning Preferred Stock?

Above all, like many SA readers and writers, I am a curious investor – I look forward to constantly learn, re-learn, and de-learn with this wonderful community. With the above background, here are my current holdings and their weight in my current portfolio. BTW, I wish Seeking Alpha encourages authors to not only disclose their ownership of a given security, but also to disclose the size of their position. Instead of showing the arguments and analysis, show how much you actually hold. How much we actually hold tells more about our true opinion than our analysis. As you can see from the following chart, over the past decade, as the interest rate declined from over 3% to about 1%, the yield from PFF followed in tandem from 7+% to less than 5% now.

The reasons are its income potential, extra diversification due to its low correlation to my other holdings, and the opportunity to generate extra alpha by dynamic allocation. As to be discussed in this post with more details, it provides a relatively high yield with good stability.

PFF Technicals

Learn more about dividend stocks, including information about important dividend dates, the advantages of dividend stocks, dividend yield, and much more in our financial education center. While all three offer unique exposure to the preferred stock market, all three also present some concerns. Since 2006, have been actively analyzing stocks and the overall market, managing various portfolios and accounts and providing investment counseling to many relatives and friends. An author, teacher & investing expert with nearly two decades experience as an investment portfolio manager and chief financial officer for a real estate holding company. Rebecca LakeRebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She’s worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S.

Preferred stock typically pays higher dividend yields than common stock, and often higher than bonds. You’re more likely to recover at least some of your investment in a corporate liquidation than you are with common stocks. Though it is possible to get capital appreciation on both bonds and preferred stock, that will only happen if interest rates fall. Like bonds, they pay steady dividends and get in line ahead of common stock upon corporate liquidation.

Pros and Cons of Preferred Stock

Here is a look at ETFs that currently offer attractive income opportunities. Fact sheets are issued by the ETF provider and framed by ETF Database. Information contained within the fact sheet is not guaranteed to be timely or accurate. This section compares the dividend yield of this ETF to its peers.

preferred stock etfs pros and cons

Since most preferred stock ETFs track the same or similar benchmark indexes, low costs become one of the main features to look for when trying to get the best deal for your money. The high dividends and lower market risk of preferred stock ETFs may appeal to risk-averse investors, more so than stocks. Because they share so many features with bonds, many investors consider preferred stock to be a sort of hybrid security. Issuing corporate bonds, on the other hand, raises a company’s D/E ratio, which doesn’t send as good of a signal to the public. Preferred shares usually don’t come with voting rights , so preferred stockholders don’t typically have much say in a company’s elections and major business decisions. That means their holders do not have a say in the important affairs of the corporation, such as a merger or amending the corporate charter. They also cannot participate in the election of the board of directors at annual shareholder meetings.

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