When looking for more stability and higher yields, many investors are turning to preferred stocks. These securities have some characteristics of regular stocks but also have some characteristics
of bonds. According to Barrons, they are currently paying higher yields than junk bonds at an approximate rate of 6 percent. Many of these stocks are issued by highly capitalized, investment-grade-rated financial institutions. Payouts are usually taxed as qualified dividend income, which are eligible for a reduced tax rate of 15 percent to 20 percent — much less than the top marginal rate of 37 percent.
From a safety standpoint, preferred stockholders have a priority over common stockholders. Negative news that could cause the price of the common stock to fall may have little or no impact on the price of the preferred stock as long as the news isn’t a threat to the company’s continued existence.
If a company does fail and needs to be liquidated, the preferred stock holders have a superior claim to a company’s assets over the common stock holders. Similarly many preferred stocks pay a cumulative preferred dividend. This means that if a preferred dividend is cut, the issuing company must repay the missed payments before the common stock holders ever get another dividend. Companies will try very hard to avoid missing a dividend payment to its preferred stock holders because it may drive up their cost of borrowing in the future.
Many preferred stocks are perpetual, which means they have no set maturity or buyout date, though they often can be called back by the issuer after a certain time. Perpetual preferred stocks have interest-rate risk similar to long-term bonds because they have no maturity date. However, there are some preferred stocks that give the stockholder the option to sell back to the issuer at a preset value, typically the investor’s purchase price, which can greatly reduce or even eliminate interest rate risk.
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