As investors cast about for alternatives for the beaten-up stock market, preferred stocks are garnering attention in some circles. Two reasons: above-market returns (up to 7 percent is not unheard of) and several new mutual funds consisting mostly of preferred stocks. “Preferreds are very effective if understood and used correctly,” says certified financial planner Brian Orol. “They can be a good way for investors to earn a steady stream of income, effectively lowering the risk of the equity stake.”
Preferreds pay quarterly dividends, making them of special interest to those looking for a steady income stream rather than big capital gains, such as single parents or people who plan to retire in the next five years, says Orol, president of Strategic Financial Planning Group in Raleigh, North Carolina. He says the average diverse portfolio should include about 3 percent to 10 percent in preferreds, with near-term retirees at the higher end of that scale. He personally chooses individual stocks over preferred-stock mutual funds.
There are drawbacks to preferreds, of course. One is that the issuing company can buy back the shares at almost any time. Another is the limited number of shares available to buy, because the universe of companies with preferred stock is much smaller than the common-stock market.
Preferreds take a little bit of research because it’s essential to understand each company’s long-term ability to pay dividends. But for certain people they may be worth the hunt.