Dear Mr. Berko: We are the 81- and 83-year-old seniors (we travel and live together) who you advised to take the $28,000 cash value from two life insurance policies and invest it in dividend utility stocks. It took us nearly nine months to get our money, because the insurance man wanted us buy a variable annuity with the money. The broker we took the money to recommended a Preferred Stock Exchange Traded Fund paying 6 percent called PowerShares Financial Preferred. Please tell us what a preferred is and if this is OK instead of a utility, which does not pay 6 percent.
SG and DL,
Dear S&D: Preferreds are a class of corporation ownership with the unique characteristics of a bond and a common stock. Like bonds, preferred stocks are issued with a fixed par value and pay dividends (not interest) at a fixed rate, based upon that par value. For example: A preferred may be newly issued at $25 (par value) and pay a $1.50 dividend, which is 6 percent of par value and a 6 percent yield on the price. If the value of the preferred rises to $30, it still pays a $1.50 dividend, which is 6 percent of its $25 par but a yield of 5 percent on market price. And if that preferred falls to $20 it still pays a $1.50 dividend or 6 percent of its $25 par but a 7.5 percent yield on market price.
Unlike bonds, preferreds are not considered debt securities — they represent equity ownership of a corporation but don't have voting power. Like bonds, their prices are sensitive to changes in interest rates. And as interest rates rise, Preferred stocks, like bonds, which are fixed income investments, will decline in price. When interest rates fall, preferreds, like bonds, generally rise in price. Unlike bonds, preferreds usually have no maturity date, but like bonds they may be redeemed (called) by the issuing corporation on a specifically published date. The redemption price may be higher (never lower) than the $25 par value, but the redemption price may be lower than the market price.
Preferred stocks are senior to common stocks. This seniority allows preferred shareholders to stand ahead of common shareholders in the distribution of dividends and in the liquidation proceeds in cases of bankruptcy. So a preferred shareholder's claims are junior to bondholder's claims. And like convertible bonds, some preferreds are convertible into a specific number of common shares of the issuing company. This feature allows preferred shareholders to simultaneously lock in an attractive yield and participate in the potential appreciation of the common stock. It's almost like having the best of both worlds.
Preferred stocks, like bonds, are rated by both Standard & Poor's and Moody's. However, their ratings are generally below that of the same company's bond because preferred dividends, which are declared by the board of directors, do not carry the same guarantee as bond interest payments. Meanwhile, there's an interesting tidbit about preferreds about which few folks are aware. If corporations park excess cash in preferred securities, the IRS allows them to exclude 70 percent of the dividends they receive from their taxable income.
Power Shares Financial Preferred (PGF-$18.50) is an Exchange Traded Fund that owns a $1.72 billion portfolio of BBB, BB and B rated preferreds that comprise the Wells Fargo Hybrid Financial Preferred Index. Ownership of preferreds like Credit Suisse, ING Groep, Bank of America, HSBC, Met Life, PNC Financial and Wells Fargo, enables PGF to pay a monthly dividend of 9.1 cents ($1.09 annually) yielding 5.9 percent. Its cousin, PowerShares Preferred Portfolio (PGX-$14.81) owns a $1.98 billion portfolio of A, BBB, BB, B and NR, rated preferreds from the BofA Merrill Lynch Core Plus Fixed Rate Preferred Securities Index (now that's a mumble). Issues like Barclays, JP Morgan Chase, Morgan Stanley, Citigroup and Synovous, allow PGX to pay 7.7 cents a month (92.4 cents annually) yielding 6.23 percent. Either is fine. And if you girls decide to visit the Florida beaches, stop by for a cup of tea.
Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at email@example.com.