Broadly speaking, preferred stocks can bolster income-generating portfolios, but some active management via the Principal Spectrum Preferred Securities Active ETF (CBOE: PREF) offers investors income and some protection.
Preferred stocks are a type of hybrid security that shows bond- and equity-like characteristics. The shares are issued by financial institutions, utilities, and telecom companies, among others. Within the securities hierarchy, preferreds are senior to common stocks but junior to corporate bonds. Additionally, preferred stocks issue dividends on a regular basis, but investors don’t usually enjoy capital appreciation on par with common shares.
What makes PREF all the more important in today’s low-yield climate is the consistency of preferred dividends.
“Preferred stock offers consistent and regular payments in the form of dividends, which resemble bond interest payments. Like bonds, shares of preferred stock are issued with a set face value, referred to as par value. Par value is used to calculate dividend payments and is unrelated to preferred stock’s trading share price,” according to Nasdaq.
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Like common stock, preferred stock is issued by a company and traded on an exchange. Preferred stock prices can fluctuate, but most of the returns from preferred stock come from dividends. Unlike common stock, preferred stock dividends are predetermined and paid at regular intervals. These dividends are paid in full before any dividends are released to common stockholders.
“Preferred stock dividends are not guaranteed, unlike most bond interest payments. If a company’s profits slump or it’s in the red and losing money, the company may choose to reduce or even end dividend payments,” according to Nasdaq. “Common stock dividends are reduced or eliminated before preferred stock dividends, although even preferred stock dividends may be lowered or eliminated in certain cases.”
Income investors have looked to preferred stock ETFs in their portfolios for a number of reasons. For instance, the asset class offers stable dividends, does not come with taxes on qualified dividends for those that fall into the 15% tax bracket or lower, is senior to common stocks in the event liquidation occurs, is less volatile than bonds and provides dividend payments before common shareholders.
“Preferred stocks do provide more stability and less risk than common stocks, though,” notes Nasdaq. “While not guaranteed, their dividend payments are prioritized over common stock dividends and may even be back paid if a company can’t afford them at any point in time.”
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.