Investing in these types of shares involves understanding some intricacies, but once you get the hang of it, it can be quite rewarding. To start off, it's crucial to wrap your head around what they are. They sit kind of halfway between common stocks and bonds. They provide higher dividend yields than common stocks, which often makes them attractive. For instance, while common stocks of a company might yield a 2% dividend, these shares might offer around 5% or even 6%. Your neighbor who bragged about his hefty 5.5% dividends from his utility's preferred shares? His excitement is not misplaced.
One of the first tasks is to identify companies that issue these stocks. Major companies across sectors, including banking giants like Bank of America and tech players like IBM, frequently have them. They often offer them as a means of raising capital. For instance, in 2020, Bank of America issued billions of dollars worth. It's essential to keep tabs on these companies through news sources or financial reports to stay informed about new issuances.
Now, how do you buy them? Like common stocks, you can purchase them through brokerage accounts. Major online brokerages like Charles Schwab and Fidelity offer platforms where you can trade them. According to a 2021 report by Charles Schwab, about 10% of their retail clients have preferred shares in their portfolios. This means you won't be alone in navigating this landscape. Plus, the transaction fees are usually no more than those for buying common stock.
Risk assessment remains paramount. While these stocks generally provide more stability than common stocks, they aren't free from risks. For example, during the economic downturn of 2008, many financial institutions that issued billions of dollars of these shares faced severe stress. Even their dividends, which are often assumed to be a given, can be suspended under financial duress. Citigroup, a massive presence in the banking world, suspended dividends on its preferred shares during that period. If you think they provide an ironclad guarantee of returns, think again.
Let's talk about callability. Often, companies issue them with the option to 'call' them after a certain period, like five or ten years. This means they can redeem them, usually at a premium. For example, if you bought a share at $25, the company might call it back at $27. Sounds good, right? Well, not always. If you're counting on a long-term investment, being 'called' after a few years can upset your planning. Imagine banking on a steady 5% annual yield, only to have your shares redeemed sooner than expected.
Then there's the question of why you're investing. Are you looking for steady income or potential growth? Consider two investors: One, a retiree named John, values predictable income more than potential market gains. The other, a young professional named Lisa, is more willing to endure volatility for the chance of higher profits. John might favor preferred shares of a stable utility company, while Lisa might find them too restrictive. Align your investment choices with your financial goals and risk tolerance.
What about dividends versus interest? Financial professionals often refer to the dividends from preferred stocks as being somewhat similar to bond interest. However, dividends from these shares can be more tax-efficient. The qualified dividend tax rate, which is often just 15% for many investors, applies here. This can result in meaningful tax savings when compared to bond interest, which gets taxed as ordinary income. If you’re wondering about the tangible benefits, consider this: On a $1,000 annual dividend, you might save hundreds in tax compared to bond interest.
And don't forget diversification. Just because you find a high-yield preferred stock doesn't mean you should put all your eggs in one basket. Spreading investments across various sectors—such as finance, utilities, and consumer goods—can mitigate risks. Even if one industry takes a hit, your entire portfolio won't necessarily crumble. For instance, in 2021, while tech stocks soared, some energy companies lagged. But those with diversified portfolios had a smoother ride.
Liquidity is another aspect to consider. While many of these shares are publicly traded, they don’t always boast the same liquidity as common stocks. Some might find it challenging to sell quickly at the desired price. Imagine holding shares of a mid-sized regional bank and struggling to sell them during a downturn. Ensuring you invest in stocks with decent trading volumes can alleviate this issue.
Preferred stocks can offer a sweet spot for certain investors, but one must understand where they fit in the broader ecosystem of investments. To gain a more nuanced understanding, compare them with common stocks and bonds, weighing risk factors, callability, taxation, and liquidity concerns. For more insights, you can read about Preferred vs Common Stock. Equip yourself with knowledge and a clear strategy, then navigate the market confidently. You're not just investing dollars, you're building a future.