May 2016 Whitepapers

There’s something about the word ‘preferred’ that puts a smile on your face. It conjures up images of better treatment, faster service, and lower rates. It’s the antithesis of the ordinary, everyday, common experience.

But is that the case if you’re an investor? Should preferred stock get an allocation in your equity portfolio? In some ways, preferred stock resembles common stock. For example, both types give you an ownership stake in the issuing corporation and the right to share in its profits. And you can sell both preferred and common stock in the secondary market whenever you please.

But the differences between the two vehicles are more striking than their similarities. Preferred stocks were not on the radar of most investors until just a few years ago. When bond yields began to fall, investors started to hunt for yields in other places, thus discovered preferred stocks.

But what exactly are preferred stocks? What advantages do they offer investors? And why do they belong in your portfolio?

The big attraction of preferred stocks is their dividend yield. Most pay above 5% annually, and can pay 8% or more. As a result, some trade above the par value at which they were originally issued, because investors are willing to pay a bit more than par to obtain the higher yield.

Most preferred stock provides regular income in the form of a dividend, which must be paid before any dividends are disbursed on the corporation’s common stock. The dividend is not linked to the company’s profitability the way common stock dividends are, so the amount is usually fixed at issue, hence does not increase or decrease later.

In some cases, the corporation may issue participating preferred shares. In this case, preferred shareholders receive an additional payment if the dividend on its common shares is more than the preferred dividend.


Equally important, if the corporation cannot pay preferred dividends on schedule, they usually accrue until the company is once again able to pay them. Not so with common stock dividends, which may be cut or eliminated if the issuing company is having financial problems or decides to use its profits in other ways.

When it comes to tax treatment, however, common stock has the advantage, because its dividends are usually taxed at your long-term capital gains rate: 15% maximum. By contrast, most preferred stock dividends are taxed at your regular ordinary income rate.

Unlike investors who own common stock, holders of preferred stock usually do not have voting rights. In fact, one reason why privately held corporations sometimes choose to raise capital with preferred rather than common stock is to avoid giving shareholders any say on matters of corporate governance






IS NOW THE TIME FOR PREFERRED STOCKS?


Lately, I’ve been often asked whether preferred stocks will remain an attractive asset class in a rising-rate environment. While preferred stocks may, indeed, see price declines as traditional long-term bonds would, the losses may be more than offset by the potential yield. Additionally, because we expect the rate rises to be gradual, we wouldn’t expect to see big downward spikes in preferred prices.

Preferred stocks may also be attractive because they are issued mainly by financial companies, like banks. That is because banks have historically tended to do well in rising-rate environments, as they can benefit from making loans at higher interest rates.

When we search for yield, preferred securities end up in nearly every WT Wealth Management portfolios, we add preferred stocks in a variety of formats: exchange-traded funds (ETFs), mutual funds, closed-end funds, and even individual issues.



As you can see, from the pie chart to the right, banks and financials make up a big chunk of the iShares US Preferred Stock ETF (symbol: PFF). One of our favorites, this ETF had a 5.79% yield as of May 2, 2016.

As we mentioned earlier, rising interest rates may not affect preferred shares as much as one might think. The attached graph shows the sector weights for the iShares US Preferred Stock ETF (PFF). Banks make up as much as 40.4% of the ETF. Financials as a whole make up ~68% of the fund.

Now, financials tend to do well when interest rates rise, and rates usually rise when the economy improves. Given the cyclical nature of financials, rising interest rates would actually benefit them — especially banks, as explained previously.







Banks’ profitability has been hurt since the Great Recession of 2007-09, as interest rates remained at record lows throughout that time and low rates even persist today. However, as the Federal Reserve gets ready to raise rates for the first time in ten years, banks may see increased profitability, which would positively affect preferred stocks in our opinion.

As with any investment decision we make, the bottom line is whether the potential return on a specific security justifies the risks we take in owning it. With preferred stocks, we like the risk/return profile. And, with a 5.79% yield more than three times the current yield of the 10-year treasury, we believe that nearly all investors should have an allocation to this misunderstood asset class.

Disclosure


WT Wealth Management is a manager of Separately Managed Accounts (SMA). Past performance is no indication of future performance. With SMA’s, performance can vary widely from investor to investor as each portfolio is individually constructed and allocation weightings are determined based on economic and market conditions the day the funds are invested. In a SMA you own individual ETFs and as managers we have the freedom and flexibility to tailor the portfolio to address your personal risk tolerance and investment objectives – thus making your account “separate” and distinct from all others we potentially managed.

An investment in the strategy is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.

Any opinions expressed are the opinions of WT Wealth Management and its associates only. Information is neither an offer to buy or sell securities nor should it be interpreted as personal financial advice. You should always seek out the advice of a qualified investment professional before deciding to invest. Investing in stocks, bonds, mutual funds and ETFs carry certain specific risks and part or all of your account value can be lost.

In addition to the normal risks associated with investing, narrowly focused investments, investments in smaller companies, sector ETF’s and investments in single countries typically exhibit higher volatility. International, Emerging Market and Frontier Market ETFs investments may involve risk of capital loss from unfavorable fluctuations in currency values, from differences in generally accepted accounting principles or from economic or political instability that other nation’s experience. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Bonds, bond funds and bond ETFs will decrease in value as interest rates rise. A portion of a municipal bond fund’s income may be subject to federal or state income taxes or the alternative minimum tax. Capital gains (short and long-term), if any, are subject to capital gains tax.

Diversification and asset allocation may not protect against market risk or a loss in your investment.

At WT Wealth Management we strongly suggest having a personal financial plan in place before making any investment decisions including understanding your personal risk tolerance and having clearly outlined investment objectives.

WT Wealth Management is a registered investment adviser located in Scottsdale, AZ. WT Wealth Management may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. Any subsequent, direct communication by WT Wealth Management with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of WT Wealth Management, please contact the state securities regulators for those states in which WT Wealth Management maintains a registration filing.

A copy of WT Wealth Management’s current written disclosure statement discussing WT Wealth Management’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from WT Wealth Management upon written request. WT Wealth Management does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to WT Wealth Management’s web site or incorporated herein, and takes no responsibility therefor. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly

WARRANTIES & DISCLAIMERS

There are no warranties implied.
Any opinions expressed on this website are the opinions of WT Wealth Management and its associates only. Material listed on this website is neither an offer to buy or sell securities nor should it be interpreted as personal financial advice. You should always seek out the advice of a qualified investment professional before deciding to invest. Investing in stocks, bonds, mutual funds and ETF’s carry certain specific risks and part or all of your account value can be lost.

At WT Wealth Management we strongly suggest having a personal financial plan in place before making any investment decisions including understanding your personal risk tolerance and having clearly outlined investment objectives.

View Disclosure
WT Wealth Management is an SEC registered investment adviser, with in excess of $100 million in assets under management (AUM) with offices in Flagstaff, Scottsdale, Sedona and Tucson, AZ along with Jackson Hole, WY and Las Vegas, NV. WT Wealth Management is a manager of Separately Managed Accounts (SMAs). With SMAs, performance can vary widely from investor to investor as each portfolio is individually constructed and managed. Asset allocation weightings are determined based on a wide array of economic and market conditions the day the funds are invested. In an SMA, each investor may own individual Exchange Traded Funds (ETFs), individual equities or mutual funds. As the manager we have the freedom and flexibility to tailor the portfolio to address an individual investor's personal risk tolerance and investment objectives – thus making the account “separate” and distinct from all others we manage. An investment with WT Wealth Management is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Any opinions expressed are the opinions of WT Wealth Management and its associates only. Information offered is neither an offer to buy or sell securities nor should it be interpreted as personal financial advice. Always seek out the advice of a qualified investment professional before deciding to invest. Investing in stocks, bonds, mutual funds and ETFs carries certain specific risks and part or all of an account's value can be lost. In addition to the normal risks associated with investing, narrowly focused investments, investments in smaller companies, sector and/or thematic ETFs and investments in single countries typically exhibit higher volatility. International, Emerging Market and Frontier Market ETFs, mutual funds and individual securities may involve risk of capital loss from unfavorable fluctuations in currency values, from differences in generally accepted accounting principles or from economic or political instability that other nations experience. Individual bonds, bond mutual funds and bond ETFs will typically decrease in value as interest rates rise. A portion of a municipal bond fund's income may be subject to federal or state income taxes or the alternative minimum tax. Capital gains (short and long-term), if any, are subject to capital gains tax. Diversification and asset allocation may not protect against market risk or investment losses. At WT Wealth Management, we strongly suggest having a personal financial plan in place before making any investment decisions including understanding personal risk tolerance, having clearly outlined investment objectives and a clearly defined investment time horizon. WT Wealth Management may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. Individualized responses to persons that involve either the effecting of transactions in securities, or the rendering of personalized investment advice for compensation, will not be made without registration or exemption. WT Wealth Management's website is limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications, and links. Accordingly, the publication of WT Wealth Management's website should not be construed by any consumer and/or prospective client as WT Wealth Management's solicitation to effect, or attempt to effect transactions in securities, or the rendering of personalized investment advice for compensation, over the internet. Any subsequent, direct communication by WT Wealth Management with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A copy of WT Wealth Management's current written disclosure statement discussing WT Wealth Management's registrations, business operations, services, and fees is available at the SEC's investment adviser public information website (www. adviserinfo.sec.gov) or from WT Wealth Management directly. WT Wealth Management does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to WT Wealth Management's web site or incorporated therein, and takes no responsibility therefor. All such information is provided solely for convenience purposes and all users thereof should be guided accordingly.

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