- Preferred stocks can offer investors greater assurances than common shares in terms of both knowing that they will receive the dividend payment and knowing what the dividend amount will be. Since preferred securities are higher in seniority than common equities, dividends must be paid to preferred shareholders before common shareholders. Also, since most preferreds provide a fixed dividend payment, an investor will know what amount to expect at the next payment date. In times of poor performance, a company will be more likely to either cut the common dividend amount or cancel the dividend altogether, rather than cut the preferred dividend amount.
- Historically, preferred stocks have offered higher yields than other asset classes including money market accounts, common stocks and bonds. For institutions and individual investors seeking current income, the high yields are seen as attractive investments.
- In addition to higher yields, preferred stocks have low correlations with other asset classes such as common stocks and bonds, thus providing potential portfolio-diversification and risk-reduction benefits. It is important to note that preferred securities exhibit higher correlation with high-yield bonds and equities, which are more sensitive to credit, and lower correlation with investment-grade corporate and municipal bonds, which are more sensitive to interest rate risk.
- Preferreds have a tax advantage over bonds, as many preferred dividends are qualified to be taxed as capital gains as opposed to bond interest payments, which are taxed as ordinary income.
Phillip Brzenk, CFA
Associate Director, Index Research & Design
Aye Soe, CFA
Director, Index Research & Design
For more on preferreds, read our recent paper, “Digging Deeper Into the U.S. Preferred Market.”