This property can bring investors huge profits with preferential tax rates.
Preferred stocks can provide investors with attractive income — and favorable tax rates — but they should be cautious before adding them to their portfolio. Preferred stocks are hybrid assets, combining the attributes of bonds and stocks, and their issuers include banks and utility companies. They trade on exchanges just like stocks, but they also pay investors a steady stream of quarterly income. In addition to offering attractive yields in excess of 6%, preferred stocks can also provide investors with tax-advantaged income: Their coupons are generally – but not always – enjoyed. The tax rate is similar to qualified dividends, which are levied at 0%, 15% or 20%. Meanwhile, corporate bond interest payments are subject to ordinary income tax rates, which can be up to 37%. But investors who find this tax-advantaged yield attractive will need to grapple with the offer’s unique risk profile. “The preference market is complicated,” says Ken Waltzer, a certified financial planner and senior vice president at Wealth Enhancement Group in Los Angeles. He said these securities represent no more than 15% of his clients’ fixed income allocations. “There are a lot of warnings,” he added. Unique feature Priority is offered to retail investors with a fixed denomination of 25 USD. The coupons that these issues pay can be fixed for their entire term, or they can be “fixed to floating,” meaning that after a certain period of time, the rate will be can be adjusted. These instruments have long maturity dates – and many can be perpetual. However, they also usually have a call date, which is when the issuer can buy them back. Indeed, issuers have increased the number of priority calls in recent months, liquidating more than $15 billion in the latest three-month period, according to UBS Financial Services. “The calls are primarily from bank issuers that offer fixed-to-floating interest rate incentives,” said Frank Sileo, fixed income strategist at the chief investment officer for the Americas. currently recoveries are floating and reset at relatively high levels, sometimes above 9%. at UBS, in a report dated June 21. When individual securities are called in, investors must hunt for replacement securities. Finally, preferred stock holders near the bottom of the list will be paid in the event of the issuer’s bankruptcy. Preferred investors will be paid before shareholders, but they are behind bondholders in terms of priority. Because of these risks, investors purchasing preferred stock should monitor the credit rating of the issuer. For example, the rating agency Standard & Poor’s considers companies with credit ratings below BBB- to be below investment grade. “The important thing with investment-grade rated offerings is that even though they rank lower in the structure,” said Collin Martin, fixed income strategist at the Schwab Center for Financial Research, capital compared to traditional bonds but they tend to be issued by higher rated companies.” Exploiting the market Shopping according to personal preferences requires a lot of effort. An alternative is to look for an exchange-traded fund that focuses on incentives, a move that helps investors avoid too much exposure to a certain issuer or a certain sector of the market. school. Waltzer highlights the First Trust Preferred Stock and Income ETF (FPE). This actively managed fund has a 30-day SEC yield of 5.82%, a total return of about 5.8% in 2024, and an expense ratio of 0.84%. Furthermore, about 71% of its holdings have credit ratings in the BBB range. Holdings as of June 26 included shares issued from Wells Fargo and Barclays. There’s also the iShares Incentive and Income Securities ETF (PFF), which has a 30-day SEC yield of 6.33%. The fund has a year-to-date total return of over 4% and an expense ratio of 0.46%. Wells Fargo and Citigroup are among the notable issuers in PFF’s portfolio, but lithium producer Albemarle and renewable energy company NextEra Energy are also on the list. While yield and total return are important, they are not the only factors that influence your decision when you buy an ETF. Keep a close eye on your expense ratio because higher fees will reduce your profits.
