PFF: Harness the Dividends and Safety of Preferred Stock

I’m the world’s most boring 30-something investor. For every small speculative investment I hold — read: my 2014 Best Stocks pick Tesla (TSLA) — I own some nine or 10 sleepy blue-chip dividend stocks or index funds.

iShares U.S. Preferred Stock ETF PFFBut I’ll tell you what: I sleep awfully well at night. And nothing puts my restful Z’s into high gear like one of my favorite holdings, the iShares U.S. Preferred Stock ETF (PFF).

And if you’re looking for a little investment piece of mind, I’d suggest you consider holding PFF as well, or find another way to get at least some preferred stock exposure.

Why Preferred Stocks?

The iShares PFF site itself gives the CliffsNotes breakdown of preferred stocks. Namely, that they “have characteristics of bonds (pay a fixed dividend) and stocks (represent ownership in a company).” And as you’d guess from PFF’s 5.8% SEC yield, they have high yields to boot.

But it’s worth spelling out a few more important details:

  • Preferred stocks are, as iShares says, like regular stocks in that you own equity in a company. However, if you care about stock voting rights, you should note that most preferreds don’t have ’em.
  • Preferred stocks do, as iShares says, pay a fixed dividend — one based on a fixed par rate assigned when the stock is issued.
  • Because of that fixed rate, preferred stocks tend to be more sensitive to interest rates than regular common stock — just like bonds. When interest rates rise, bonds need to fall in value to offer more competitive yields. Preferred stocks can act in the same fashion, but…
  • Preferred stocks tend not to be as sensitive as bonds, in part because of their often considerably higher yields.
  • It’s also because preferred stocks’ dividends are more secure, as they have higher priority (Hey! They’re preferred!) than common stock dividends. A company must pay out preferred dividends before common dividends, and even in cases when a common stock’s dividend is suspended, the preferred stock might go untouched.
  • Of course, if a a preferred stock’s dividend is cut, it probably means the company is in a dire financial situation … but it’s one you’re likely to see coming.

Why PFF?

Do you believe in diversification? If you’re playing it safe, of course you do. So, if you’re trying to get access to a particular part of the market — especially one in which you’re looking for safety — why would you hold one preferred stock when you could hold hundreds?

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That’s what the iShares U.S. Preferred Stock ETF offers. Specifically, 315 holdings of U.S.-listed preferred stock, much of which is issued by companies in the financial, insurance and real estate sectors. That means preferred stock from companies like Citigroup (C) and Wells Fargo (WFC), as well as U.S.-listed European financials such as Barclays (BCS) and HSBC (HBC).

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What does that get you? Well, this chart shows us two important things:

#1: Safety (Usually): In normal times, PFF is about as safe and secure as you want. Since the beginning of 2010, PFF has maxed out around $41 and bottomed out around $35.50 — a max difference of about 13.5% from the top. You’re not going to make money on capital gains.

That said, PFF has averaged an annual return of 12.72% since Jan. 1, 2010. The S&P 500, which is up some 70% since then? Annual average returns of 14%. That’s the power of PFF’s dividends talking.

#2: All Bets Are Off in a Crisis: Preferreds are protected, but not invulnerable. When the crap really hits the fan, PFF can tank just like anything else. During the financial crisis, dividends were cut to common and preferred shares alike. And considering that the iShares ETF is built so heavily on financials, it’s no wonder that investors actually fled PFF (-66% from 2008 peak to 2009 trough) to a greater extent than they did the S&P 500 (-53%).

Of course, most anything you can trade on the markets stands the risk of collapse when the U.S. economy and stock market fall on their face. PFF is merely no different, for better and for worse.

Bottom Line

Where the iShares U.S. Preferred Stock ETF shines is total long-term returns built on substantial dividends. While it won’t ramp up alongside rip-roaring markets, it won’t necessarily tank, either, if markets merely correct.

And that’s what you want when you’re looking for stable investments that you can depend on for decades. Collect your roughly 6% a year, reinvest it for a couple decades, and PFF will take care of itself.

I wish I could say the same about the rest of my portfolio.

Kyle Woodley is the Deputy Managing Editor of InvestorPlace.com. As of this writing, he was long PFF and TSLA. Follow him on Twitter at @KyleWoodley.