If you could earn 5% to 6% in income every year from a stock you don’t have to watch … you’d hold it today, right?
Well, if you don’t already, here’s your wake-up call.
Preferred stocks are a rarely talked about type of corporate equity that packs a one-two punch of high yield and low volatility. But that’s not why they’re called “preferred” – that moniker comes from the fact that preferred dividends take priority over common shares’ dividends, and must be paid out first. If a company wants to cut or suspend its payouts, it must do so to common shares before preferred shares.
And better still, if the preferred stock is cumulative, a company that has suspended its dividends must pay out any unpaid dividends on preferreds before it can resume paying a dividend on its common stock.
Not a bad deal for shareholders!
A few other must-know traits of preferred stocks:
- They pay out a fixed dividend, similar to a bond’s coupon rate.
- Preferreds do not have voting rights, just like bonds.
- Some preferred stocks are actually callable, meaning the issuing company can “call” them back by purchasing them at their par value – the price at which they were issued.
But again, what really draws all the investors to the yard are preferreds’ yields, which typically sit at 5% or higher, at such low, low volatility. To give you an example of how little preferred shares move, here’s a look at the three-year returns for JPMorgan Chase & Co. (JPM) and the company’s Series B preferred shares.
Chart Courtesy of Morningstar
But for as relatively safe as preferred stocks are, there’s always more safety in numbers.
Which is why if you want to leverage the power of preferred shares, you should consider doing so using exchange-traded funds (ETFs), which will deliver instant diversification without sacrificing any of that supple yield.
iShares U.S. Preferred Stock ETF (PFF)
The iShares U.S. Preferred Stock ETF (PFF) is the gold standard in preferred stock funds. It holds nearly 300 individual preferred securities while still offering a 30-day SEC yield of 5.3% — more than enough to offset a decent (but not cheap) 0.47% in expenses.
The above chart shows how PFF compares to a another favorite in the high-yield space: junk bond ETFs. Specifically, PFF has put up a better total return over the past five years than the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the SPDR Bloomberg Barclays High Yield Bond ETF (JNK). And it has done so with slightly less volatility for much of that time.
One thing to note about PFF – and many other preferred ETFs as well – is that most of the fund’s holdings are clustered in financials of one sort or another. More than 40% of ETF’s weight is in banks such as Wells Fargo & Co (WFC) and HSBC Holdings plc (ADR) (HSBC), with another 20% in diversified financials and still almost 10% more in insurance. Real estate is the only other major sector weight at 11%.
This is important to know, because for as steady as preferreds tend to be, the financial crisis of 2008-09 still wreaked havoc on PFF, and a similar crisis in the future would pose a similar risk.
VanEck Vectors Preferred Securities Ex Financials ETF (PFXF)
It’s that very risk that led to the 2012 launch of the VanEck Vectors Preferred Securities Wx Financials ETF (PFXF).
The PFXF is exactly what the name implies: A fund full of preferred stocks that excludes the financial sector, which results in a somewhat narrower 118-holding offering. Electric utilities such as NextEra Energy Inc (NEE) make up about 30 percent of the fund, as do real estate investment trusts (REITs). Telecoms such as top holding T-Mobile US Inc (TMUS) make up another 15%.
While PFXF is light on banks, it’s certainly not light on income. In fact, its 30-day SEC yield sits at 6.2%. That dividend is paid out monthly, by the way, just like PFF and several other preferred ETFs.
All told, since PFXF’s inception, you haven’t been sacrificing a single point in returns by eschewing financials.
PFXF has returned a bit more, and it even charges a slightly cheaper 0.41% (thanks to a small fee waiver).
Global X SuperIncome Preferred ETF (SPFF)
The last of these ETFs – Global X SuperIncome Preferred ETF (SPFF) – is a pure yield chase.
SPFF goes back to the traditional formula of preferred ETFs, with about 70% of the fund invested in financial stocks. Energy is the only other double-digit sector holding at 10%, and REITs, telecom, consumer staples and materials round out the rest of the portfolio.
But SPFF is a very narrow fund focused on only 50 of the highest-yielding preferreds. The upshot? A 6.9% 30-day SEC yield. The downside? The investment in somewhat riskier preferreds has led to underperformance over much of the fund’s life.
The lesson: This is a riskier ETF than most preferred plays — and pricier, at 0.58% — but it can’t be beat for sheer income potential.
Your Best Preferred Bet Pays 8%+
Be careful about these “one-click” diversifications, however. They actually expose you to unnecessary credit risk.
The only way you lose with this vehicle is by giving your money to a driver who crashes your car. But the S&P 500 and NASDAQ are large enough that there’s usually a company financially crashing into a brick wall at any moment in time.
And if we include the brick wall the financial world ran into ten years ago, these funds haven’t even performed to their current yields:
The Problem With Financial Brick Walls
I suspect PFF, PFXF and SPFF probably won’t actually return 5% or 6% annually over the next decade, either. Which why I recommend moving past a broad-based ETF in favor of a fund with an active manager working for you. There’s extra yield to be had in preferred shares – but you should make sure you have an expert buying your stock to keep you safe and on the road.
My two favorite funds today pay over 8% each. They’re excellent bargains because they are closed-end funds selling at discounts to their net asset values (NAVs).
Earlier this year, investors irrationally sold any and all closed-ends down to silly bargain prices. Some deservedly so, but these two high quality preferred funds – with excellent management teams and track records – were swept away by the hysteria.
That’s great for us. Low prices mean higher yields plus some upside as these funds gradually close their discount windows. And these 8%+ yields net us 27% more income, and do so more securely, than their ETF counterparts. Plus, these funds have a history of actually delivering these types of returns over the long haul (unlike the more popular ETFs).
Lesser-known high income plays like these are the cornerstones of my “no withdrawal” retirement portfolio strategy. Why rely on stock price appreciation in an inflated market when there are secure, high paying dividends you can simply live off of and keep your capital intact?
Most investors know this is the right approach to retirement. Problem is, they don’t know how to find 8% yields to fund their lives.
That’s why I specialize in finding safe, under-the-radar high income options. Click here and I’ll explain more about my no withdrawal approach – plus I’ll share the names, tickers and buy prices of my two favorite preferred funds for 8%+ yields.