Let’s face facts — even if the Federal Reserve raises rates in the short term, they aren’t going to rise to 15% overnight. That means that finding sources of reliable income is going to be on the minds of many retirement-focused investors.
While all kinds of high-yielding assets have gotten the nod from investors — from real estate investment trusts (REITs) to master limited partnerships (MLPs) — the best could be a hybrid security type.
We’re talking about preferred stocks.
Preferred stocks are kind of like a mix between bonds and equities. Like bonds, these hybrid securities feature high yields — often in the 4% to 7% range — as well as feature a par value that, after a certain maturity date, can be called by the issuing company. That provides a price floor for the preferred stock and provides protection from Fed interest rate raises. You’ll at least get that back when the preferred stock matures.
But the real benefit of preferred stock is that it is senior to common stock, meaning dividends must be paid to preferred holders before common stock holders.
For those investors who are in retirement, preferred stocks offer the best combination of yield and protection.
Accessing preferred stocks used to be a big deal. However, today it’s easier than ever. Here’s one individual preferred stock, an exchange-traded fund and a mutual fund to get you started.
Preferred Stocks for Retirement: Kinder Morgan Inc (KMI)
Dividend Yield: 10.2%
Pipeline superstar Kinder Morgan Inc (NYSE:KMI) highlights the kind of big yields investors can get with individual preferred stocks. Backed by the firm’s more than 80,000 miles worth of pipelines, terminaling assets, storage facilities and other pieces of midstream infrastructure, its Series A preferred stock is currently yielding north of 10.1%.
Part of that big yield is that the series A shares are trading for below their par value of $50. The other part of that is the preferred stock will convert to regular KMI shares after Oct. 26, 2018.
What current investors get is a very high yield and the potential for future gains — and dividend growth — when the preferred stock converts into regular KMI shares. KMI has once again regained its past trajectory of dividend increases.
Right now the discount to par represents the discount to the future conversion ratio for KMI shares. In all honesty, you could do far worse than owning shares in one of the largest midstream firms in the nation.
But for investors solely looking for high income, the next few years of owning KMI preferred stock will be very sweet indeed at that 10%-plus yield.
Preferred Stocks for Retirement: PowerShares Preferred Portfolio ETF (PGX)
Dividend Yield: 5.7%
When it comes to indexed ETF solutions for preferred stocks, the iShares U.S. Preferred Stock ETF (NYSEARCA:PFF) is the 800-pound gorilla in the room. However, investors may want to trade down towards its rival — the PowerShares Preferred Portfolio (ETF) (NYSEARCA:PGX).
The reason is yield. PGX has historically provided slightly more income than PFF — even when accounting for its slightly higher expense ratio. PGX costs just 0.5%, or $50 per $10,000 invested annually.
PGX’s underlying index — the BofA Merrill Lynch Core Plus Fixed Rate Preferred Securities Index — tracks a basket of preferred stocks that include slightly lower-rated investment grade hybrids. Moving ever-so-slightly down the credit ladder has resulted in PGX slightly outperforming — and out-yielding — PFF.
Remember, in retirement, compounding is a game of inches. That truly is enough to make a difference over the long haul.
And investors shouldn’t be scared. Because these are preferred stocks, bankruptcy risks are reduced, and these are still investment-grade firms.
In the end, the fund makes an ideal choice for those investors who are looking for an indexed way to add preferred stocks.
Preferred Stocks for Retirement: Principal Preferred Securities Fund Class P (PPSPX)
Dividend Yield: 4.6%
One of the oldest and first mutual fund companies to tackle preferred stocks is Principal. The company has a long history of funds paying monthly dividends and providing a level of stability for retirement portfolios.
The problem is that some offerings come with a nasty front-end sales load, but luckily, Principal Preferred Securities Fund Class P (MUTF:PPSPX) shares offer the same portfolio without the upfront sales commission. And there are plenty of reasons why you’d want to do that.
Principal uses outside mangers when creating its funds. In this case, it has partnered with Spectrum Asset Management. The firm only does preferred stocks, convertibles and other hybrid bonds — that’s its bread and butter.
Using fundamental research and credit analysis, Spectrum looks to find those preferred stocks that offer the best values and opportunities relative to the par/trading prices. And since it doesn’t have a mandate to only focus on investment-grade preferred stocks, PPSPX can go anywhere to find those opportunities.
That’s allowed it outperform indexed preferred funds by a few tenths of a percent. Game of inches, right? However, the yield on the mutual fund is lower. PPSPX should be thought of as a total-return element in your portfolio.
For those investors looking for an active solution to preferred stocks, the Principal fund could be a great choice.
As of this writing, Aaron Levitt did not hold a position in the aforementioned securities.