Preferred securities, sometimes called “preferreds,” share characteristics with both stocks and bonds. Traditionally, preferred securities deliver higher yields than dividend stocks or government bonds. However, it’s important to understand how these securities work so you can understand the risk that comes along with these higher yields.
Investing in Preferred Securities
Not every company offers preferred securities. The most commonly issued preferred security is preferred stock, or preferred shares. These preferred shares pay a scheduled coupon payment and have a par value paid back at maturity, similar to a bond.
However, the issuing company can halt that coupon payment at any time, similar to the dividend payment on a stock.
Preferred payments are generally issued before a company sets and pays dividends but after the company pays the interest on its bonds.
Like stocks and bonds, preferred securities aren’t just issued and held; they tend to be traded on the secondary market.
While the yields on preferred securities are comparable to high-yield debt (sometimes called junk bonds), the risk level tends to be lower. However, preferred securities aren’t right for everyone, and you may want to consult with a financial advisor before adding these investments to your portfolio.
Types of Preferred Securities
Preferred stock is just one approach to preferred securities. Before we cover the other types, let’s quickly recap the details of preferred stock.
1. Preferred stocks
A preferred stock gives you ownership in the issuing company. It differs from a common stock since it provides a fixed par value. Preferred stocks also have dividends that can be suspended at any time and are usually not cumulative.
2. Hybrid preferred securities
These include capital trust securities and junior subordinated debentures. They have interest payments that can be deferred and either cumulative or noncumulative.
3. Baby bonds
Baby bonds, sometimes called senior notes, pay interest like bonds. But these securities—unlike bonds—can be traded on a public exchange and have a typical par value of $25.
Choosing Preferred Securities
You should evaluate preferred securities carefully, considering both the potential benefits and risks. It’s also a good idea to compare preferred securities against the other investment options at your disposal.
Here are a few factors to review:
Payment options
Find out if a preferred security makes payments in interest or dividends based on its par value. These payments may be made monthly, quarterly, or semiannually. They can be provided at fixed, floating, or adjustable rates.
Dividends
Deferred or missed payments on cumulative preferred securities usually accumulate as obligations of the issuer and must be paid out before common shareholders receive their dividend payments. Payments for noncumulative options do not accumulate as obligations of the issuer, which means shareholders are not entitled to receive missed payments.
Maturity date
A preferred security has a designated maturity date. But the issuer may have the option to extend this date multiple times.
Early redemption
There are optional, mandatory, or conditional early redemption or call provisions. These enable the issuer to redeem the securities before a designated maturity date or at other times.
Convertibility
Convertible preferreds may be exchanged for a specified amount of a different security. There are often provisions attached to them that limit when they can be converted.
Taxes
How they are taxed varies. It is essential to review the taxation section of the offering documents to learn about taxation.
Yields
They can provide greater yields than traditional securities. The higher the yield, the greater the risk associated with it.
You don’t have to be an expert investor to evaluate all the options. The above can give you a good start on making a comprehensive assessment of the value of these securities so you can feel confident in your investment choice.
There are also options if you need extra help in making your evaluation. A Bogart Wealth Advisor can help you review your investment objectives and offer honest, unbiased assistance.
