July 24, 2012
Interest rates in the U.S. are at all-time lows, and investors are likely on borrowed time if they are positioned in bonds or bond funds. Market volatility has pushed investors, in many cases, too far into fixed income vehicles. As bond prices move inversely to the direction of interest rates, the eventual rise in interest rates will cause what are typically considered "safe" investments to decline in value. Until rates rise, we remain in a sideways, low interest rate environment, where it is difficult to find a steady stream of relatively high income. The yield on the 10-year U.S. Treasury was 1.44% on July 23rd-a new all-time low. Many retirees are banking on being able to minimally achieve a 4-6% total return on their investment portfolios in order to maintain their standard of living and their principle. So the question is, where do you go for relative safety, if fixed income yields are at all-time lows and future rate increases will likely lower the value of your bond portfolio?
One answer that may make sense for your portfolio is preferred stocks. Preferred stocks are hybrid stock-bond vehicles that are typically issued at a par price of $25 and trade like a stock, but that have some of the features of a bond. They have a maturity date, typically long term (ie-25 years). They often are "callable", meaning the issuer has included a provision that will let them redeem the stock (thus paying off that high interest rate debt) and return the par price for every share that you own, at a certain date(s). These shares typically trade in a relatively narrow range and have a high dividend (frequently 5-8%). As they are a hybrid bond instrument, they are obligated to pay you the interest on the stock, and in the event of a bankruptcy you would be paid your money back before the common stock holders. One strategy is to look for preferred stocks that are trading at a discount to their par value, for instance under $25 per share. When they mature or are called (at par) you have a capital gain, on top of the interest rate that you received during the time you held the stock - a win-win scenario.
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).