For those investors trying to build a widely varied income portfolio for retirement, finding high yields can be something of a challenge if you’re also trying to maintain some level of quality, be it across stocks or debt.
One idea out there is preferred stock — usually referred to as a stock/bond “hybrid” because it shares similarities to each. For instance, they can trade on open markets and appreciate/depreciate like common stock, but they pay interest just like bonds.
While preferreds do have a couple perks — companies must pay the dividends due on preferred stock before dividends to common shareholders, and in the event of bankruptcy, you have priority in any liquidation scenario to funds dispensed by a court — they also have some downsides.
Because of their bond-like characteristics, preferred shares are susceptible to interest-rate risk. Also, they can be called back (just like bonds) or converted into common shares, some preferred shares’ rates can change, and a limited number of brokerage houses will actually handle preferred trades.
That said … the risk shouldn’t scare you away. It should just color how you get exposure to them.
Rather than deal with all the individual preferred risk — not to mention the research required, the illiquid market and tax complexities — the best way to invest in preferred stock is via either mutual funds or exchange-traded funds.
A few options that can net you yields of more than 5% include:
iShares U.S. Preferred Stock ETF (PFF): Most of PFF’s holdings are preferred shares in financial, insurance and real estate companies. Like most other preferred stock funds, the PFF has suffered amid rising interest rates, with its price falling nearly 4% year-to-date, with most of that coming during the summer as rates rocketed toward 3%. However, it’s a long-term winner, with annual returns of roughly 7.5% during the past five years.
PFF Yield: 5.8%
Market Vectors Preferred Securities ex-Financials ETF (PFXF): PXFX provides a different flavor than most preferred stock funds in that it does not hold any financial preferred shares. Thus, instead, top holdings are preferred stocks from companies including United Technologies (UTX) and utility PPL (PPL). The Market Vectors fund hasn’t been around for very long, opening for business in July 2012, so it doesn’t have much of a track record. However, it’s slightly underperforming PFF year-to-date at 6.6%.
PFXF Yield: 6.3%
Nuveen Preferred Securities Fund (NPSAX): Like most preferred funds, NPSAX is loaded with banks and insurance companies, with the broader overall group representing roughly 86% of the entire portfolio. NPSAX is an actively managed fund, and it also make some of its returns through credit default swaps, which is why investors in A-class shares face a maximum 4.75% load charge in addition to 1.08% in expenses. Nonetheless, NPSAX boasts five-year annual returns north of 10%.
NPSAX Yield: 6%
Cohen & Steers Preferred Securities and Income Fund (CPXAX): CPXAX, which started in May 2010, is a bit more diversified, with financials and insurance preferreds only representing 70% of the portfolio, 10% in real estate preferreds and another 4% in telecom preferred stock. Since inception in 2010, CPXAX has boasted 8.8% annual returns, which includes its 4.5% maximum load charge and 1.1% in expenses.
CPXAX Yield: 6.3%
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing he did not hold a position in any of the aforementioned securities.