How many times have you heard this:
Preferred stock is the best of both worlds: The upside of common stock and the protection of bonds?
Not so fast.
According to a study by Guohua Li, Ph.D and Edward O'Neal, Ph.D., principals of SLCG, Inc., this view of preferred stock is "overly simplistic."
From July, 2007 to March, 2009, the S&P Preferred Stock Index fell by almost 70%, while common stocks fared relatively better, losing 50%. The bond markets had positive returns.
There is nothing "preferred" about those results.
When things are rosy, common stock holders are well rewarded. Holders of preferred stock receive far more modest returns. So much for the upside. What about the downside?
There is a reason for the much touted higher yield of preferred stocks. They are much riskier than bonds. In a down market, the shares of preferred and common stock have to descend to zero before the bond holders are affected at all.
Contrary to traditional wisdom, it appears that holders of preferred stock get the worst of both worlds. Preferred stock is riskier than bonds, but it doesn't have the same upside as common stock.
The bad news doesn't stop there.
Issuers of preferred stock are primarily financial institutions. Holders of preferred stock typically are not aware their stock is concentrated in this risky and volatile sector.
Preferred stock is also costlier to trade because it is significantly less liquid than common stock.
If your broker has recommended preferred stock for your portfolio, you need to be aware of these risks.
There is a more fundamental issue here. Why are you using a broker?
Dan Solin is the author of The Smartest Retirement Book You'll Ever Read.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.
Follow Dan Solin on Twitter: www.twitter.com/DanSolin
