Preferred stock ETFs can be a smart addition to a portfolio, especially for investors wanting an income from dividends. Keep reading below to understand the pros and cons of these funds that invest in preferred stocks and find out which ones are the best to buy now.
Here’s what you need to know.
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What Are Preferred Stock ETFs?
Preferred stock ETFs are exchange-traded funds that enable investors to buy a portfolio of preferred stocks. Preferred stock can be considered a hybrid of common stock and bonds.
The reason for this hybrid status is that preferred stocks are equity securities like common stocks but have income qualities like bonds.
Like bonds, preferred stocks are assigned a par value and they pay a stated rate of interest. The price of the preferred stock tends to fluctuate with the rise and fall of interest rates, similar to bonds. Do take note that prices move in the opposite direction of interest rates.
The Pros of Buying Preferred Stock ETFs
Buying preferred stock ETFs has many pros and cons that can provide very unique investment opportunities.
Pros of buying preferred stock ETFs:
- Higher dividends:
- Compared to common stock, preferred stock will generally pay greater dividends.
- Preference in bankruptcy:
- Preferred stocks are ahead of common stocks (but behind bonds) in order of liquidation if there is a bankruptcy proceeding.
- Less market risk than common stock:
- Dividend payments are fixed and price fluctuations are not as pronounced, compared to common stock, making preferred stocks less risky.
The Cons of Buying Preferred Stock ETFs
Cons of investing in preferred stock ETFs:
- Interest rate risk:
- Since preferred stock is interest rate sensitive like bonds, their generally not ideal investments to hold when interest rates are rising. This is because the price typically falls when interest rates are going up. However, common stock can gain price in a rising interest rate environment.
- No voting rights:
- Unlike common stock, shareholders do not receive voting rights with preferred stock.
- Minimal growth:
- The trade-off for low market risk and fixed dividend rates is that preferred stock produces little to no price gains for investors.
Conclusion
Preferred stock ETFs can be used wisely, especially for investors who are looking for a way to diversify a portfolio designed for income.
The combination of high dividends and lower market risk compared to common stock can be attractive for conservative investors. However, long-term investors looking for growth may want to look elsewhere for the best ETFs for their portfolio.
Additionally, If you are interested be sure to check out our list of bank bonuses and CD rates!
