What are preferred shares?
As an investor, you might run across the term “preferred shares”. Understanding these shares, and knowing how they work, can provide you with an improved investment portfolio, and add to your income stream.
A basic overview of preferred shares
Basically, preferred shares are a sort of hybrid between “regular” equity securities and fixed income securities. A preferred share represents an ownership interest in a company. With preferred shares, you actually own a company, much as you would if you invested in common stock. On a company’s balance sheet, the preferred shares are listed as equity.
However, there are some characteristics of a preferred share that are similar to those possessed by bonds. First of all, there are no voting rights attached to preferred shares. You do, though, receive the benefit of a regular distribution, similar to a dividend. The distribution is usually larger than what you would see with the “normal” dividend-paying shares, which makes preferred shares somewhat desirable as income investments.
If a company is required to liquidate its assets, preferred shareholders are only paid off after the creditors. So bonds are paid before these shares. But preferred shares are taken care of ahead of common shares, so you have a better chance of getting your value with preferred shares than you do with common shares.
Should you invest in preferred shares?
Everyone’s situation is different, so you should consider your individual needs and goals before you decide whether or not to invest in preferred shares. There are some advantages to these types of investments, including:
Interestingly, preferred shares don’t correlate very well with either stocks or bonds. This means that preferred shares add another asset class to your portfolio without being overly risky.
The income from these shares can be very helpful indeed. If you are trying to build an income portfolio, it can make sense to add some preferred shares in the mix, since you will see a higher yield with them than with ordinary dividend stocks.
Distributions from preferred shares are taxed as dividends, rather than as ordinary income. This means that there is a more favorable situation with these types of investments. Bonds and other fixed-income securities are often taxed as ordinary income, which means a higher tax bill.
Of course, you still need to consider whether or not preferred shares are likely to work for you. Even though they are considered to have lower volatility than regular stocks, and even though they have certain advantages, preferred shares can be a little more expensive.
You have to pay attention to the ROI and decide whether or not the higher cost is worth it to you. Another concern is its liquidity. It’s not always as easy to unload preferred shares as it might be to sell other securities.
Carefully take all of this into consideration, and think about consulting a financial professional to help you navigate the sometimes murky waters. Adding some preferred shares to your portfolio can be a good thing, but you need to make sure that they are still helping you reach your long-term financial goals.