Over the last ten years it has been increasingly difficult for the investor. Stock returns have been anemic and bond yields have dropped dramatically. In addition, the volatility of the stock market has caused many investors to shy away from stocks completely. If we look at the Spartan Total Stock Market Index Fund [FSTMX] we see an average annual 5 year return of .26% and an average annual 10 year return of 3.86%. Next we take a look at the Spartan U.S. Bond Index Fund [FBIDX] where we see an average annual 5 year return of 5.53% and an average annual 10 year return of 5.36%. Bonds have been in a decades long bull market. With the yield on the ten year treasury hovering around 2%, it makes you wonder how much more can be gained from bond fund investing.
Although many aggressive investors overlook income investments, the returns discussed above make a very strong case for diversification regardless of one’s risk tolerance. Income investments always have a place in an investor’s portfolio. However, if and when yields do rise, bond funds may take a massive hit in NAV. So how does the investor protect against that and still invest in income producing securities? Two ways that come to mind are invest in individual bonds and hold them to maturity or invest in Preferred stocks. The issue with investing in individual bonds is the cost associated with proper diversification. So as part of a diversified portfolio an investor can shift a portion of his income investments to preferred stocks.
A great place to start researching preferred stocks is Quantumonline.com. Anyone can register for free to research all sorts of income producing securities including preferreds. If anyone wishes to have a crash course in preferreds, this article sums them up pretty well.
So what companies should you consider for preferred stock investing? Since we are looking for yield the first sector that comes to mind is the big banks. In general, the big banks have taken a beating since the financial crisis. Looking at the top four banks in the U.S. measured by total assets we find Bank of America (BAC), JP Morgan (JPM), Citigroup (C), and Wells Fargo (WFC). Many might think the banks are the worst investment in the world. However, we have seen the Federal Reserve will not let the banks collapse. Ben Bernanke is watching all the big banks closely so that we do not experience a repeat of the 2008 financial crisis and the Great Depression.
The main risk of preferreds is the company stops paying dividends due to financial constraints. This did occur to investors in bank preferreds after the 2008 financial crisis and investors did not receive dividends for three years. However, the Fed has given the green light for many banks to resume dividends. It is hard to believe the Fed would allow banks to resume dividends after three years then all of a sudden say whoops, we made a mistake, and the banks have to stop paying dividends.
Here are four preferreds to consider, one from each of the largest banks. The first is Bank of America 8.625% Series 8 [BML-PQ] This security is currently trading in the 22s providing the investor with a current yield of around 9.8%. JPMorgan Chase 8.625% Series J [JPM-PI], trading in the 27s providing a current yield of approximately 7.8%. Wells Fargo 8% Series J [WFC-PJ], trading in the 28s providing a current yield of approximately 7%. Finally Citigroup 8.5% Series F [C-PM], trading in the 25s providing a current yield of approximately 8.2%.
When researching preferreds, one must note call dates, especially if the security is trading above par. Also, each website has its own spin on the ticker symbol for preferreds. Take for example Citigroup 8.5% Series F. On Yahoo Finance it is listed as C-PM. On Marketwatch it is listed as C.PM and on Quantum Online it is listed as C-M (must register to view). One other characteristic of preferreds to consider is whether they are subject to the 15% tax rate or if their dividends are taxed at ordinary income rates.
Preferred stocks seem to be the ugly duckling of the investment world. There are very few websites dedicated to them. Maybe it is due to their nature of a hybrid security. Maybe it is due to their lack of volume on a daily basis. Whatever the case, in a world where yield is hard to come by, preferred stocks provide a good reason to yield to bonds for a portion of your income investments.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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