In the past, investment grade corporate bonds or government bonds were considered a solid investment vehicle, offering a safe 6-7% interest rate. However, in today’s uncertain economic climate, this is simply not the case. For instance, the investment of government bonds with a ten-year maturity might only provide a yield of 1.6% in today’s market. Factor in the after-inflation yield and you could be looking at negative returns. So what is an investor to do? Are there any solutions that can help today’s investor overcome these scarce returns?
One thing to think about is a bond substitute, such as an investment quality preferred stock. We consider this type of investment a crossbreed of sorts which lie somewhere between a bond and a stock. Investment grade preferred stocks are a type 1 investment for 612 companies, unlike common stocks, which are a type 2 investment. In addition, the dividend qualifies for a 70% exclusion for income tax purposes. However, you just can’t jump in and buy these instruments eyeing higher yields without also understanding the risks.
You must know the details of the investment to understand what you are getting. There are risks that the company may call (force you to sell) the preferred stock, stop payment of dividends if the company is experiencing financial trouble, and they may have a very long to unlimited maturity. There are preferred stocks available in the market that mitigate these risks, but it takes a lot of effort to find them. The advisor must resolve to do the due diligence to make sure they are appropriate for the portfolio and to be aware of the risks involved. This investment instrument is not for the advisor that does not monitor their investments or take the time to read the prospectuses and understand how exactly they work.
While preferred stocks can carry a higher risk than bonds, high-quality investment grade preferred stocks can be a suitable choice and are only slightly more volatile than bonds. A diversified portfolio utilizing a measure of preferred stocks might just be the tool you need to add some stability to your investment mix and increase your portfolio returns.
Do you want to know more about using preferred stocks to generate income as a bond substitute? Contact the team at Financial Fiduciaries for more information.