Question As a retired investor seeking income I have been thinking of purchasing preferred stocks. I can keep them for many years without worrying about selling them at depressed market prices. Dp you think that banks that are participating in the TARP program will be able to make payments to preferred stockholders after covering the 5% senior preferred stock they had to sell to the Treasury?
Answer Mel, that's a really good question. Preferred stocks and similar securities can work well as part of the income portion of a retiree portfolio and some of the issues I call "mildly distressed preferreds" (those selling at slight discounts to original issue price) offer higher yields without taking on a great deal of extra risk. You have to do your homework to make sure the company isn't on its way towards insolvency, diversify across a bunch of them in case you get it wrong, and it can work out well alongside more conservative income securities.
But a key part is doing the homework and right now that's a real wildcard with any of the financials. If you're new to preferreds this is a difficult time to be picking them. There are just so many unknowns and there are two levels to it...first, the company itself - how stable is it, will its condition worsen, and how does the direction of the overall economy affect the answer? And second...well ask any AIG shareholder about regulatory risks - who knows exactly how the TARP program will work or whether that's the last intervention that's required to help stabilize the market.
I don't know who said it first, but a great quote I heard about preferreds is that they have $1 of upside and $25 of downside (referring to the typical issue price of $25/share). Because many can be called at $25/share at some point, they won't drift too far upward from that price, but in bankruptcy the preferred shares are likely worthless. Many of the higher-yielding preferreds right now are, for all intents and purposes, on par with junk bonds, with the risks that go with them. Some apparently "safe" ones lost a great deal of value very quickly at various points during the last few months, in some cases permanently. So whether these make sense for you really depends on how much risk you want in your income portfolio; if your income securities are supposed to be your source of stability, alongside common stocks...well as I said I think it's an unusually tough time to pick preferreds if you haven't analyzed them before. Sure, there's probably some good money to be made, but it's also likely that some of the issues aren't going to make it - and I don't know if I'd rely on TARP to bail out the preferred shareholders. If you can answer this question, you'll be getting stock-like returns from your income portfolio. But as they say, "there's no free lunch"...caveat emptor.
-Tad
PS resources on preferreds: www.quantumonline.com for research, as well as Barron's weekly newspaper and the online site. There are also numerous mutual funds in this asset class, though I'm not familiar with them.
