Are preferred shares right for you?

“Derek, should I consider preferred shares for my retirement portfolio?” Investors seeking income often limit their selection to bonds or guaranteed investment certificates (GICs) and give little or no consideration to preferred shares. They usually ignore preferred shares simply because they don’t know much about them.

“Derek, should I consider preferred shares for my retirement portfolio?”

Investors seeking income often limit their selection to bonds or guaranteed investment certificates (GICs) and give little or no consideration to preferred shares. They usually ignore preferred shares simply because they don’t know much about them.

Perhaps the easiest way to think of preferred shares is that they are shares of a company which behave like a bond. A preferred share represents an ownership interest in a corporation, just as common stock does. But it also produces a reliable stream of income — in the form of a pre-set dividend — very much like the interest paid on a bond or a GIC.

Just like a bond, the price of a preferred share will change with movements in interest rates. Typically, a change in interest rates tends to have more impact on the price of a preferred share than changes in the stock market.

Unlike GICs and bonds, the dividend payment from a preferred share can be more tax efficient.

That is if everything else is equal, when comparing returns a preferred share paying the same rate as a bond should provide a higher after-tax payment. This makes them attractive in a non-registered account.

Preferreds are well-suited to relatively conservative investors.

They are also useful for more aggressive investors who want to balance a portfolio heavily weighted towards growth stocks.

Part of what make preferred shares appealing includes the high yield, or dividend.

Preferred shares typically yield more in dividends than common stock issued by the same company. Since dividends are paid quarterly, many investors purchase three or more preferred issues with different payment dates to assure themselves a monthly dividend cheque.

Unlike a GIC, preferred issues are listed on the major stock exchanges, making them easy to buy and sell. Most preferred shares are issued at par values of $25, putting them well within the reach of individual investors. Older issues trade above or below their par value depending on interest rates and other market conditions.

Preferred shares rank senior to common shares — that is, preferred shareholders’ claims for dividends and corporate assets (in the event the company is liquidated) come before common shareholders’ claims.

If a company runs into serious financial problems, the board of directors may vote to reduce or skip the preferred dividend without placing the company in default. But most preferred stock is “cumulative,” so missed dividends accumulate and must be paid to preferred shareholders before any dividends are paid to common shareholders.

Keep in mind that preferred stock is junior to all the company’s debt, so in the same example, bond holders would get paid first.

There are numerous features that may be included in a preferred share. For example, some preferred shares are designed so that their dividend payment will change, or reset, every five years depending on the rate on a Bank of Canada five-year bond.

If the rate is lower than the original, your new dividend payment will be lower for the next five years. In many cases, this rate may still be higher than your typical GIC or bond.

Adding to this, a recent decline in the price of many preferred shares has to do with the decline in interest rates from the Bank of Canada.

Some preferred shares will likely reset at a lower dividend rate in the coming year and the shares are being priced accordingly.

The reality is your investment may appear lower on your statement, but you will continue to get a dividend that is likely higher than the best possible GIC rate.

In some cases there may be some attractive investment opportunities.

If you’ve noticed these changes in your portfolio it is best to review your holdings and understand your strategy moving forward.

Since preferred shares are unique and unfamiliar to most investors it is best to discuss them further with a qualified advisor before deciding if they are right for you.

Wealth Watch is written by Derek Fuchs, a wealth advisor with ScotiaMcLeod in Red Deer. It is provided for informational purposes only and any opinions contained in it are his own. Readers are urged to consult a wealth advisor for help with their personal investment circumstances. Fuchs can be contacted at derek.fuchs@scotiamcleod.com.

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