Preferred Stock Dividends

Preferred Stock Dividends

Posted On September 2, 2021 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

As part of our Core and Satellite portfolio models, our investors have received Preferred Stock Dividends for several years. Preferred Stocks are different from Common Stock as they are a hybrid security which combines the features of a stock and a bond. Like a stock, preferreds trade on an exchange and pay a quarterly dividend. Like a bond, preferreds are issued at a Par Value ($25) and can be called or redeemed by the issuer in the future for $25.

If you’d like a primer on Preferred Stocks, check out my previous article, Preferred Stocks Belong In Your Portfolio. Or check out Forbes, What is Preferred Stock?

The Role of Preferreds

The preferreds we own have yields from 4-6% or more. Today, with the yield on 10-year Treasury Bonds around 1.25%, preferred stock dividends offer a nice rate of return compared to bonds but without all of the volatility of common stocks. And with the current high valuations on US Stocks, Preferred Stocks offer us an alternative that complements our stock and bond holdings. It’s a nice way to diversify our holdings, but preferreds remain a small, niche investment that most people have never owned.

Presently, our Premiere Wealth Portfolios have between 7-11.5% in Preferred Stocks. In our Defensive Managers Select portfolio, we have a 20% position in Preferred Stocks. Those are significant weights for a satellite position, but it remains a small piece of our overall allocation.

We buy a basket of individual Preferred Stocks. For each client, we will own a minimum of 5 and as many as 15 individual Preferred Stocks. As of today, our largest holdings include Capital One, Wells Fargo, Regions Financial, JP Morgan, and Brookfield Finance. Most preferreds are issues by financial companies, although there are some issued by real estate and utilities, too.

I prefer to own individual preferreds to have better control over the portfolio and keep costs down. Generally, I like to buy Exchange Traded Funds. And there is an ETF for preferreds: PFF from iShares. Two problems. First, the ETF owns many preferreds trading at a very large premium to Par. That means you would be buying a preferred at $27 that could be redeemed at $25 within 5 years. We have to look at the Yield to Call to understand this. Second, the ETF has an expense ratio of almost half a percent (0.46%), and that would reduce investors’ return. In a sector where the expected return is only 4-5%, that expense ratio would be a big drag on returns.

Managing Preferreds

Within our baskets of preferreds, we’ve had quite a few trades this summer. Generally, for most of my clients, we own preferreds in IRAs, since they create taxable income. In an IRA, we can trade without any capital gains impact. With yields falling this year, there has been a high demand for Preferred Stock Dividends. And this has pushed up the price of many Preferred Stocks. This is not a good time to just blindly buy any Preferred Stocks – many are very expensive.

So, we have been rotating from preferreds with higher prices to those with lower prices. In some cases, a Preferred with a high dividend payment actually has a low Yield to Call. If you are paying $27 for a preferred that is callable for $25, you are paying an 8% premium. And that premium will decline to the call date, creating a loss of capital that will eat into your total return. I am finding opportunities to improve our preferred stock dividends with some careful trades.

Trading and Upgrading

There are a couple of scenarios where we have placed trades to replace one preferred with another.

  1. Price comparison. Here are two preferreds with the same coupon of 4.45% and similar credit ratings and call dates. The Schwab (series J) is trading at $26.57, while Regions Financial (series E) is at $25.60. This is an opportunity to sell an expensive share and use the proceeds to buy more shares of the lower priced preferred.
  2. Same company, different series. Capital One’s series L has a coupon of 4.375% and the series N is at 4.25%. Both have the same call date of September 2026. There is a one-eighth of a percent difference in coupon. So, when the L’s were trading for 2.5% more than the N’s, that is too big of a difference. We sold the L’s and bought the N’s. Then this week, the prices swapped and we were able to sell the N’s and buy back the higher yield L’s for less. Many companies have multiple series of preferred stocks. Sometimes one is more expensive and the other is less expensive, for no logical reason. We’ve also swapped between the Goldman Sachs series C and D, which both have a 4% coupon.
  3. New issues. We can buy IPOs of Preferred Stocks. We’ve bought a new JP Morgan preferred at $25 this summer and it is now up to $25.56. Other times, we have been able to buy preferreds for below $25 for a few days after the IPO, when the issue was undersubscribed. We’ve bought shares of Regions Financial and Texas Capital Bancshares at a discount this way. Over a few weeks, new issues usually move to where similar preferreds are priced.

Long-Term Outlook

I’ve been looking at all types of income securities for the last 17 years. Not just Preferred Stocks, but Closed End Funds, MLPs, REITs, and individual corporate and municipal bonds. It’s a lot of time to manage individual securities correctly, and it takes skill and knowledge that takes years to develop.

I like the idea of Preferred Stock Dividends to add income to our portfolio models. And that’s the purpose behind our Alternatives sleeve to the portfolio: to seek investments with a better return than bonds, and lower correlation and volatility compared to stocks.

For now it’s working as I had hoped. What might change this? If we see the Federal Reserve start to raise interest rates and see the long-end of the yield curve move up, this would be negative for preferreds. That’s why this is a Satellite holding and not a Core. There may well come a day that we liquidate the preferreds for another asset class with better prospects. Even though we are buy and hold, long-term investors, by no means is the approach a purely passive portfolio. Rather than looking in the rear view mirror, we construct portfolios looking forward at the challenges we see facing markets today.

Have a question about Preferred Stock Dividends? Curious about your Retirement Income? Let’s talk about our portfolios and how they might work for you. Click Contact on the top of this page to get in touch!

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10 Rules for Playing Defense in Investing

Posted On May 31, 2019 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

Stocks take the stairs up and the elevator down. When they rise, it is slow and steady, but when they go down it feels like a free-fall. Given the recent market tumult, I wanted to share my top ten rules for defensive investing.
Defense doesn’t mean that you won’t have losses on days when the market goes down. It means that you avoid unnecessary risks that could really blow up your portfolio, so you can have the confidence to stay with the plan.

1. Diversification is the only free lunch in investing. You should be diversified by company, as well as by sector and country. If your employer issues you stock options or has an Employee Stock Purchase Plan, take every opportunity to sell and diversify elsewhere. Most disaster stories I hear are from people who failed to diversify.

2. Index Funds are the antidote to performance chasing. When you pick a concentrated fund, such as a sector fund or single country fund because of its recent track record, you risk buying at the top and experiencing a painful (and much larger than necessary) drop when the winds change direction. While it’s so easy to find actively managed funds that beat the index over the past year, there is a better than 80% chance that those funds will lag the index over the next five or more years. The Index fund is also likely a fraction of the cost and is also more tax-efficient than an actively managed fund.

Read More: Manager Risk: Avoidable and Unnecessary

3. Asset Allocation is the most important decision you make. Start with a carefully measured recipe so you don’t end up with a random collection of funds and stocks you’ve acquired over the years. If you’ve decided that a 60/40 portfolio is the right mix for your needs, that should be for all market environments, not just while stocks are going up.

4. You are going to be tempted to adjust your Asset Allocation. It is very tough to get this right, because humans are wired to make terrible investing decisions. We want to sell a down market and we want to buy when the market is at all-time highs. Obviously, in hindsight, we should buy when things are really ugly and sell at the peaks. Invest with your brain and not your gut-feeling.

Read More: Are You Making These 6 Market Timing Mistakes

5. Rebalance. When you have a target asset allocation, then the process of rebalancing back to your target levels creates a built-in process of selling assets which have shot up in value and buying assets which have temporarily gone out of favor. This works great with Funds, but don’t try this will individual stocks.

6. We buy stocks for growth and bonds for income and safety. When you try to switch those objectives, things seldom go as planned or hoped. Buying stocks for their yield and safety can easily lead to long-term under performance. Many times you will be better off in a plain vanilla index fund than a basket of super-high dividend stocks or supposedly safe stocks. Many high-yielding stocks are very low quality companies with no growth. When they do eventually cut their dividends, the shares plummet.

Similarly, you can find bonds that as quoted, should yield stock-like returns. Stay away. These could be future bankruptcies.

Read More: Bonds for Safety in 2019

7. Don’t use margin. Keep cash on hand. If you don’t thoroughly understand options, avoid them. Don’t buy penny stocks or stocks on the pink sheets.

8. Dollar Cost Average in every account you can. 401(k) accounts are ideal. You will often make most of your gains on the shares you purchased in a down market, you just won’t know it until later. 

9. Take your losses. Don’t play the imaginary game of “I will sell it when it gets back to even”. If you are in a crummy fund, replace it with a more appropriate fund. We tax-loss harvest in taxable accounts annually and immediately replace each sale with a different fund in the same category (large cap value, emerging markets, etc.). 

Read More: Why You Should Harvest Losses Annually

10. Stick to the Plan. Don’t make abrupt, knee-jerk changes. Investing adjustments should not be all in/all out decisions. Keep opening your statements, but recognize that a bad day, month, quarter, or year doesn’t mean that anything is wrong with your plan. Of course, if you didn’t start with a plan, that’s another story.

We genuinely believe that no one can repeatedly time the market and that the attempts to do create significant risk to your long-term returns. I try to convey this message consistently. Last week, a friend asked if all my clients were panicking about that day’s drop. And I said that I hadn’t gotten a single call that day, because they know we are in it for the long haul and have already positioned their portfolio with their goals in mind. 

It will not surprise you that I think you are more likely to be a successful investor if you work with an advisor who can make sure you start with a plan, stick to an asset allocation, and implement your plan with sensible investments. Along the way, we will rebalance, make adjustments, and monitor your progress. We are looking to help more investors in 2019 and would welcome an opportunity to discuss how our approach could work for you. 

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