Sustain Your Portfolio With Preferred Stock

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Includes: AV, FCX
by: William Tracy

Summary

Steady value through market volatility.

Dividends provide an excellent avenue for compounding returns.

Preferred stocks currently hold 48% of my portfolio and provide 90% of dividends.

There are numerous articles and reports about preferred stocks across the internet and Seeking Alpha but none really explain their value to new, young investors. Millennials and other new investors are faced with a huge educational gap about the financial industry with the impending need to plan for retirement, somehow, without exposing themselves to extreme risk. I have managed to acquire an allocation of what I believe are fantastic PFDs that have yielded 5-8.25% in dividends annually along with appreciation of over 1% since purchase.

Some of my favorite PFDs are below for reference:

Preferred stocks, if used correctly, can provide serious long term benefit to portfolios through compounding returns. Common stocks that pay high dividends are okay, but they still have a large risk factor. We saw what happened to Freeport McMoRan (FCX) over the past year, and that's just one large cap example. So taking a dividend from preferred stocks, compounding it annually, and watching balances accumulate is a great way to offset downside risk through common stock. Consider my purchase of Aviva (NYSE:AV) if I hold it for 10 years and reinvest quarterly dividends. My asset value over doubles in that time frame which may protect from losses elsewhere or at least ensure a steady accumulation of wealth.

PFD's may yield little fluctuation and allow for peace of mind during trying times in the market, but there are still a couple of rules I like to follow and I believe others looking to purchase PFDs should as well.

First, I never purchase a PFD above its initial coupon price. When the stock gets called, it will be repurchased at the initial coupon price and, no matter how much in yields I plan to receive, I do not believe in starting at a loss. The best time to purchase PFDs, in my opinion, is after an ex-date. The price will typically drop due to the dividend giving potential a window to purchase below coupon. This also allows for investors to enjoy a quick gain, when the stock grows above coupon, which is always nice to see on an account summary.

Second, investors need to research their companies. It's important to know the company's dividend paying history and ratio of common to preferred stocks. This allows for investors to make sure they will be purchasing an equity that will pay out steadily and retain value. Reading up on PFD ratings is also a good idea. Those ratings are not always foolproof but they can add an additional layer of assurance.

Third, sell those that can be replaced. If an investor owns a PFD that pays out 5.6% and discovers another that yields 6%. Assuming their values parallel, it would be prudent to sell the lesser before its ex-date and purchase the latter immediately after its ex date. This equity swap is beneficial to portfolio growth.

Fourth, be wary of interest rates. Rising interest rates have the ability to devalue preferred stocks. That being said, The Fed's progress in rate hikes and continuing that strategy remains to be seen. Current low interest rates make it prime time to enter into these securities.

It's up to investors to educate themselves about where they want to put their money but, at least for the young investors, don't rule out preferred stocks because they are new to you. They may prove themselves to be an excellent investment vehicle for years to come.

Disclosure: I am/we are long AVV, HBHCL, DTQ.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.