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Preferred Stocks for Higher Yields

- Alan Lavine and Gail Liberman



Are preferred stocks for you? They yield 8 percent or more.

A lot depends on your tolerance for risk.

Preferred stocks are almost more like bonds than stocks. Preferred stocks pay a fixed dividend, but those who own them lack the voting rights they would have with common stocks. If a company goes belly-up, preferred stockholders get paid before common stockholders. Bondholders, however, get paid first.

Preferred stocks yield about 2 percent more than corporate bonds and 5 percent more than U.S. Treasury Securities. The reason: They are riskier. So, if you plan to invest in preferred stocks, it's best to own a diversified group of preferred stocks rated BBB to AAA by Standard & Poor's or Baa to Aaa by Moody's.

You also can invest in preferred stock funds. These are professionally managed and diversified. Preferred closed-end stock funds include: John Hancock Preferred Income Fund, The Preferred Income Fund, and Preferred Income Opportunity Fund and the Nuveen Quality Preferred Income Fund.

It's best to own preferred stocks along with CDs, corporate bonds, U.S. Treasury bonds and cash. That way you are sure to be well-diversified. When one investment zigs, the other zags. Losses in one asset will be offset by gains in the other investments.

Adding preferred stocks to your bond holdings should zip them up. A diversified group of preferred stocks has outperformed the Lehman Brothers Aggregate Bond Index (a diversified group of bonds) by almost 2 percentage points in annual total return over the past 10 years ending in March 2002. This, according to financial research by Spectrum Asset Management, Stamford, Conn. And, this group of preferred stocks was 25 percent less volatile than bonds.

But, there is no free lunch with preferred stocks. For example:

  • If interest rates rise, preferred stock prices decline.
  • Bad news about a company or industry could send preferred stock prices tumbling.
  • Preferred stocks can be called. In other words, the issuer can decide to redeem the shares. That means you could be forced to reinvest your money at lower rates.

A company may suspend the preferred dividend during tough economic times.

On the plus side:

  • Preferred stocks should benefit if dividends are not taxed under President Bush's tax proposal.
  • Most preferred stock issues are cumulative. In other words, the dividends will accrue even if they are not paid. When business improves, the dividends are paid back.
  • Preferred stockholders' rights to the dividends can prove invaluable in a worst-case scenario. During The Great Depression of the 1930s, 41 percent of the 243 industrial preferred stocks traded on the New York Stock Exchange paid their full dividends every year. Another 24 percent paid the dividends back in cash within a reasonable time period, according to a 1942 Ph.D. dissertation by Roger F. Murray written for the Graduate School of Business, New York University. The remaining 35 percent did not.

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Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).


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