Many risk-averse, income-oriented investors in this low interest rate environment have put their hope in preferred stock dividends. But are preferred stocks with an average yield of nearly 7% a safe oasis in the “howling wilderness” of fixed income investments, asks Jason Zweig in his Wall Street Journal column, “Preferred Stock: Are Those Juicy Yields Worth the Extra Risk?” In a word, no, for several reasons.
First, preferred stocks are more volatile than junk bonds. In September 2008, the Standard & Poor’s U.S. preferred-stock index declined 26% – triple the decline in “junk” bonds. Even in a bull market, preferred stocks are about 10% riskier than junk bonds, according to economist Eddie O’Neal of Securities Litigation & Consulting Group in Fairfax, Va.
Second, preferred stock dividends can be shut off at will ? like common stock, unlike bonds. That happened during the financial crisis when regulators suspended preferred stock dividends of Fannie Mae and Freddie Mac, and many other banks stopped paying their preferred dividends.
Third, preferred stock can be “called away” if the issuer wants to retire it.
Fourth, preferred stock funds are often over-concentrated in financials. For example, 84% of the assets of the iShares preferred ETF are in financial firms, according to the article. Over-concentration in a sector of the economy ? such as the financial sector ? increases the risk of loss, and that increased risk was very evident during the financial crisis.
Fifth, income from a preferred stock fund could be taxed as ordinary income rather than the lower 15% rate for dividends, depending on whether the fund held the preferred shares for at least 61 out of the 121 days on either side of the dividend date. The same rules apply to individuals who own preferred stock; sell too soon and your tax rate could double.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing institutional and individual investors in investment-related litigation and arbitration all over the country. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 40 occasions.