Since January 3, 2000, the stock market has returned negative 26.5%, excluding dividends. The only returns conservative investors that broadly invest in the market would have gotten was the roughly 2% a year in dividends. In other words, long-term investors that diversify are probably frustrated with common stocks.
When stock market returns are expected to continue to be poor there are two options: beat the stock market or invest in other securities.
One way investors can beat the stock market is by concentrating their holdings. If you only invest in the five best ideas you have and wait patiently for a good entry point, you have a much better chance of beating the market than if you invested in your top thirty ideas. Many investing gurus such as Carl Icahn, Edward Lampert, Bruce Berkowitz, Seth Klarman, and Bill Ackman invest in a concentrated portfolio. It has also been the philosophy of Warren Buffett and Charlie Munger. In fact, the issue of diversification was one of the only issues on which Buffett disagreed with his mentor Benjamin Graham.
Another way investors can beat the market is by timing. If an investor has the right temperament and only invests when there is a rare opportunity to put money to work at depressed prices, such as 2009 and right now, he or she will do very well. Hetty Green, the richest woman in America at the beginning of the 20th century and dubbed the “Witch of Wall Street” once said, "I buy when things are low and no one wants them. I keep them, just as I keep a considerable number of diamonds on hand, until they go up and people are anxious to buy. That is the general secret of business success." Over 100 years later, in 2008, Warren Buffett wrote in a NY Times Op-Ed, "A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful."
The downside to investing only when the market is depressed is obvious: during bull markets you might be sitting on the sidelines. Therefore, instead of going to the extreme of getting into and out of the market at certain times, one can stay invested at all times but with a larger allocation of income generating securities when the market is overvalued or when you just can’t find anything great to buy.
Currently, the market is not overvalue and there are opportunities to get into great companies at great prices. Finding these opportunities requires hard work, brain power, and the right temperament. For investors who don’t have the time or skill to do the necessary research, preferred stocks might be a more comfortable way to get good long-term returns. Preferred stocks are also suitable investments for people in retirement looking for income or for people who don't like the volatility of common stocks.
Preferred stocks should also be a part of your portfolio if you believe the market is not going anywhere--much like it has been in the past 12 years--because the dividends are larger than most common stocks.
The widely publicized purchase of preferred stocks in GE, Goldman Sachs (GS), and Bank of America (BAC) by Warren Buffett in the last few years brought some attention to preferred stocks, but not much. For example, even though Buffett feels Bank of America is safe enough to put his reputation on the line for it, and $5 billion, Bank of America Preferred J shares are still yielding 8.60%. In addition to the 8.60% dividend yield, investors will get about a 20% gain in principal if the price goes up to $25, which is the redeemable price.
Below are eight preferred shares with attractive dividend yields. All of them have a redeemable price of $25, except Homeowners Choice, which has a redeemable price of $10. Each preferred share of Homeowners Choice is also convertible into a share of common stock.
Shares Current Price Current Yield Call Date Date of Maturity Cumulative Ally 8.5% Preferred B $16.70 12.70% 5/15/2016 none no Bank of America 7.25% Preferred J $19.50 9.30% 11/1/2012 none no Barclays 7.75% Preferred C $21.30 9.10% 3/15/2013 none no Capital One Capital 7.5% Preferred B $25.00 7.50% 6/15/2011 6/15/2066 yes Homeowners Choice 7% Preferred A $8.80 8.00% 3/31/2014 none yes JP Morgan 7% Preferred C $25.00 7.00% 2/15/2007 2/15/2032 yes Vornado Realty 6.875% Preferred J $25.50 6.70% 4/20/2016 none yes Wells Fargo 8% Preferred J $26.40 7.60% 12/15/2017 none no
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I have clients with long positions in the stocks mentioned in the article.