Rate cuts shouldn’t induce any angst for equities investors, but for fixed income investors, this could affect the income of their current portfolio. This is where exchange-traded funds (ETFs) focused on preferred stock can help.
Fixed income investors can take some solace in knowing that rate cuts won’t come swiftly. The Fed appears to be taking a cautious approach to rate cuts, falling in line with its objective to guide the economy to a soft landing.
“I think we’re in a good place, but I think from here it’s a new phase and we’re going to be cautious about further cuts,” said Fed chairman Jerome Powell, following the most recent rate cut of 25 basis points.
Much of the hesitance to implement cuts has been the strong economy. As a result, sticky inflation is causing the Fed to pump the brakes on quick rate cuts, which allows fixed income investors to position themselves to reap the income benefits of preferred stock dividends.
Rather than pick individual stocks for preferred exposure, the Invesco Variable Rate Preferred ETF (VRP) provides an easier way. The fund tracks the ICE Variable Rate Preferred & Hybrid Securities Index. This allows for exposure to mostly floating- and variable-rate, investment-grade and below-investment-grade, U.S. dollar-denominated preferred stock and hybrid debt publicly issued by corporations in the U.S. domestic market. As of December 20, VRP has a 30-day SEC yield of 5.37%.
Investors who are anxious about the market uncertainty surrounding a new, incoming presidential administration in 2025 should also look to preferred stocks. Preferred equities typically exhibit a lower volatility profile versus their common stock counterparts when comparing the historical data between the two.
Tax-Advantaged Income
An additional benefit of qualified dividends is their tax-advantaged income. When compared to dividends from common stock, qualified dividends max out at a tax rate of 20%, based on the 2024 rates.
Common stock dividends are taxed at the standard income rates, reaching as high as 32% for the highest bracket. For high-income earners, this makes qualified dividend income an ideal choice to minimize their tax burden.
For example, a single individual making between $100,000 a year, or $200,000 for married couples filing jointly, would fall under the 24% tax rate.
| 2024 tax rate | Single | Married filing jointly |
|---|---|---|
| 12% | $11,601 to $47,150 | $23,201 to $94,300 |
| 22% | $47,151 to $100,525 | $94,301 to $201,050 |
| 24% | $100,526 to $191,950 | $201,051 to $383,900 |
| 32% | $191,951 to $243,725 | $383,901 to $487,450 |
That same individual and couple would fall under the 15% tax rate if they were to derive their dividend income from preferred stocks.
| 2024 tax rate | Single | Married filing jointly |
|---|---|---|
| 0% | $0 to $47,205 | $0 to $94,055 |
| 15% | $47,025 to $518,900 | $94,055 to $583,750 |
| 20% | Over $518,900 | Over $583,750 |
For more news, information, and analysis, visit the Innovative ETFs Channel.
