For income seekers, preferreds offer great deals. Yields average 6.1%, well above the 2.3% payout of the Barclays Aggregate U.S. Bond index. Preferreds also beat the 2.1% dividend yield of Standard & Poor’s 500-stock index, along with higher-yielding areas of the market, such as utility stocks and real estate investment trusts.
But preferreds pose risks, too. As bondlike investments, they’re sensitive to swings in interest rates and would lose value if rates were to rise sharply. Preferreds could also tumble if banks and other big issuers of the stocks run into a financial buzz saw.
Yet in a normal market climate, preferreds should beat high-quality bonds as a source of steady income. Plus, preferred dividends tend to be taxed at rates well below those for bond interest, making preferreds a better deal if you’re in a high tax bracket.
Below, we offer a primer on these stocks and show you how to research and buy them — and recommend four.
What are preferred stocks? Similar to common stocks, preferreds represent an ownership stake in a company. The shares pay a fixed, preset dividend, typically every three months. They’re called preferred because companies must pay dividends to preferred holders before they can pay dividends on common stocks. Banks, insurers and other financial firms issue more than 80% of preferreds. You can also find preferreds from companies in industries such as energy, health care and telecommunications
Companies typically issue preferreds at $25 per share, known as par value. Once preferreds start trading, prices move up or down, often in response to changes in interest rates. As with bonds, prices of preferred shares usually fall when rates rise and climb when rates fall.
Are preferred dividends guaranteed? Companies can miss a payment without triggering a technical default (as missing an interest payment on a bond would do). Some preferreds are cumulative, meaning that any missed dividend payments would add up and have to be distributed before common stockholders could receive their next dividend payment. However, most preferreds are noncumulative, letting the company off the hook for missed payments.