The Basics of Preferred Stocks

By Dan Caplinger | September 12, 2012

The Motley Fool has helped ordinary people become better investors for nearly two decades. This month, we're reaching out to millions of investors to help guide them in their quest toward financial knowledge and independence.

Along those lines, I'm planning to take a look at some different types of investments that many people aren't as familiar with, as well as the popular exchange-traded funds that allow you to make those investments. Today, I'd like to focus on preferred stocks in general and on the iShares Preferred Stock ETF (NYSE - PFF) in particular.

Why buy preferred stock?

Novice investors often think preferred stock simply refers to shares of high-quality companies. But in actuality, preferred stock is a much different type of investment than regular common stock.

Preferred stock combines elements of both stocks and bonds. Preferred stock pays dividends that are usually higher than what common shareholders receive, and if a company goes under, they get paid before common shareholders get anything. But because their dividends are usually fixed, preferred stock doesn't have the growth potential that common shares offer.

You can buy individual preferred stocks on regular stock exchanges. But the benefit of the iShares ETF is that it aggregates more than 250 different preferred stocks into a single portfolio. That's part of the reason why the ETF has become so popular, with more than $10 billion in assets under management.

One concern about the ETF has to do with its concentration in financials. Wells Fargo (NYSE - WFC), Bank of America (NYSE - BAC), and Citigroup (NYSE - C) are just a few of the big financial firms you'll find regularly using preferred stock to get capital, and within the ETF, you'll find substantial exposure to banks, insurance companies, and other financials. Only a few issuers, such as Ford (NYSE - F), hail from outside the financial industry, and even in Ford's case, its extensive financing operation looks a lot like the lending portfolios you'll see at many major banks.

iShares Preferred Stock also comes with substantial costs. You'll pay annual expenses of around $48 for every $10,000 you invest, which isn't dirt cheap, although it's less than what most active mutual funds charge. But the income you'll get is substantial, with a $10,000 portfolio generating more than $550 in annual dividends.

Learn more

Preferred stock can be useful, and iShares Preferred Stock opens the door to an asset class that many investors never consider. To learn more about iShares Preferred Stock, use this link to the ETF's main information page.