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Ask a Fool: Are Preferred Stocks Safe Fixed-Income Investments?

By Matthew Frankel, CFP® - Jan 25, 2019 at 12:00PM

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Preferred stocks have generally higher yields than bonds, but there's a catch.

Q: As a retiree, my primary investment objective is income. I was thinking of adding some preferred stocks to my portfolio. Is this a smart move, or should I stick with bonds?

Preferred stocks can certainly be a good way to get a high yield in your portfolio. For example, the 10-year U.S. Treasury yields less than 2.8% as of this writing, and even long-term A-rated corporate bonds yield about 5.1% on average.

And it's not difficult to find preferred stocks with significantly higher payouts. Upon a quick check, I found preferred stocks issued by top-notch institutions like JPMorgan Chase, AT&T, and Goldman Sachs that yield 6.6%, 5.6%, and 5.9% respectively.

Having said that, it's important to point out that there's no free lunch in investing. In other words, there's a reason why these fixed-income investments pay such attractive yields.

For one thing, preferred stock dividends aren't guaranteed. They are paid out of the company's earnings, and while they have priority over common stock when it comes to dividend payments, there have been situations where companies with no earnings choose not to declare preferred stock dividends. In most cases, however, any missed dividends need to be paid back before any dividends at all can be paid to common shareholders (known as "cumulative" preferred stock).

A similar arrangement exists if a company goes through a bankruptcy reorganization or ceases operations altogether. When this happens, preferred stockholders have a subordinate claim to any company assets behind bondholders or other creditors but will have a superior claim to common stockholders.

The bottom line is that like any bond, preferred stock is only as strong as the company that issues it. And because of the subordinate nature, investors can expect a bit more yield than they'd get with a bond investment.

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