a preferred stock guide
Warren Buffett
Gerard Miller CNBC
Billions Warren Buffett is a champion in investing.
Berkshire Hathaway CEO is famous for buying and holding stocks – and does not resort to market volatility.
He is also known for making huge estimates in companies, such as the $ 900 million shares he has in Amazon.
His last game: An investment of $ 10 billion to repay the Occidental Petroleum's bid for Anadarko Petroleum. Berkshire Hathaway will make the investment by purchasing 1[ads1]00,000 preferred stock shares, which pay an annual dividend of 8%.
Preferred shares are different from ordinary shares, the best known ones are familiar with. Both are equity in a company, but the preferred share usually pays a higher dividend. And it can be attractive in this current low-interest environment.
"Think of it as a hybrid security," certified financial planner Colin Gerrety, client adviser at Glassman Wealth Services.
"It has some aspects similar to ordinary stocks," he added. "It also has some aspects of what looks like a ribbon."
Diversification is probably the most important thing to look at this asset class.
Marguerita Cheng
CEO of Blue Ocean Global Wealth
] So when is it a good idea to follow Buffet's footsteps and invest in a preferred stock?
"If you have a little extra capital, you have a long time horizon, and it's consistent with your investment goals, this could be something you might want to consider," said Marguerita Cheng, a CFP and CEO of Blue Ocean Global Wealth .
But don't just wade in before you find out if it's the right move for you. Here are some advantages and disadvantages of investing in preferred stocks.
Revenue Revenue
If you want higher and more consistent dividends, a preferred equity investment can be a good addition to your portfolio.
While it tends to pay a higher dividend than the bond market and ordinary stocks, it falls in the middle of risk, Gerrety said.
"The benefit of a preferred stock tends to be safer than a stock dividend, but it's not as safe as investing in a traditional bond," he explained.
For example, Wells Fargo's stock market yield rate is 3.92% and it offers several preferred options ranging from a 7.5% return to a 5.125% dividend. Semper Energy's ordinary share has a dividend of 2.96%. It also issues a mandatory convertible preferred share with a current return of 6.19%. The convertible feature is an option for the shareholder to exchange his stock for share capital at a predetermined conversion rate.
It is also important to know that dividends are not guaranteed – they are paid out of the company's earnings, just like a common share dividend.
However, there are several different types of preferred stocks, and it may be important to collect dividends that the company missed.
Cumulative shares, like the type Buffett in Occidental, require the issuer to collect any deferred dividend payments and repay it to the shareholder in the future. In this case, the preferred shareholders have priority over common shareholders when they receive a refund.
On the other hand, if a company issues a non-cumulative share, it is not necessary to pay the missing dividend. However, due to the higher risk involved, these shares have a higher return than cumulative shares.
Interest rate sensitivity
The main risk of investing in preferred stocks is that the assets, such as bonds, are sensitive to changes in interest rates. There is a reverse relationship between the interest rate and the price of not only fixed income securities, but also hybrids as preferred shares.
If interest rates increase, preferred stocks on the market make less attractive, so they tend to sell at lower prices [19659011] Colin Gerrety
Client Advisor at Glassman Wealth Services
"If interest rates increase, preferential stocks make the market less attractive, so they tend to sell at lower prices, "Gerrety said.
The company can also call back the preferred stock when it chooses, based on the provisions of the prospectus, he pointed out.
This means that if the interest rate falls, the issuer has the right to call back the share. It may then issue new shares with lower dividends.
Voting rights
Preferred shareholders do not have voting rights, so they have no vote when it comes to things like choosing a board. [19659002] However, joint shareholders have voting rights.
Tax
It is a tax advantage for preferred equity investors, as dividends are often taxed at qualified dividend rates.
It is lower than income from a Bonds, which is taxed as ordinary income, says Gerrety.
Other Risks
Investors should also look more closely at the preferred stock market, which is much smaller than for ordinary stocks and therefore not as floating, Gerrety said. As of Thursday, the preferred stock market was $ 272 billion, according to the S&P Dow Jones indices.
It also has a higher concentration of financial companies, which took great success in the financial crisis of 2008. That is because most sectors, except tools, generally do not issue so many preferred stocks.
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In fact, S & P US Preferred Stock Index has 71% of its holdings in the sector, as of 30 April. The S & P 500 aims to have sector diversity, the US Preferred Stock Index consists of all stocks that meet their qualification requirements – and thus result in heavy weighting in financial stocks.
"Investors can look at the returns and think that it's a good way to earn some stable income, and in the absence of shocks in the system, that might be the case," he said. "But it's more risky than investing in traditional secure bonds."
Bottom line
"Diversification is probably the most important thing when looking at this asset class," Cheng said.
To get that spread, look at listed funds or mutual funds that will give you a basket of preferred stocks, such as iShares US Preferred Stock ETF.
Also, start a little when you dive into the market and "make sure you buy things you understand," says Cheng.
Above all, don't forget to think about your broader investment portfolio, Gerrety says.
Investors "Must keep in mind what their overall goals are," most of the time, preferred stocks should not make up a significant part of it, he says.
"Most investors' risk and return investments can be achieved through traditional equity and bond share classes. "
