Preferred stock ETFs can be a smart addition to a portfolio, especially for investors wanting an income from dividends. Learn the pros and cons of these funds that invest in preferred stocks and find out which ones are the best to buy now.
- Preferred stock ETFs combine the traits of stock and bonds for a unique type of investment.
- The high dividends and lower market risk of preferred stock ETFs may appeal to risk-averse investors, more so than stocks.
- Preferred stock ETFs do not often produce major growth or high long-term returns.
- When shopping for preferred stock ETFs, costs and returns will be important factors.
What Are Preferred Stock ETFs?
Preferred stock ETFs are exchange-traded funds that enable investors to buy a portfolio of preferred stocks. But what exactly are preferred stocks? Preferred stock is like a hybrid of common stock and bonds. The reason for this hybrid status is that preferred stocks are securities that deal in equity, like common stocks, but they have income traits like those of bonds.
Like bonds, preferred stocks are assigned a par value and they pay a stated rate of interest. The price of the preferred stock tends to change with the rise and fall of interest rates. As with bonds, the price of preferred stock moves in the opposite direction of interest rates.
Preferred stocks are also unique in that they receive priority status if there were a bankruptcy and liquidation proceeding with the corporate issuer. For example, if a company needed to liquidate all their assets per court order, preferred stockholders would receive money (if any remains) before the common stockholders (but after the creditors and bondholders). This explains the "preferred" label.
The Pros and Cons of Buying Preferred Stock ETFs
Before buying preferred stock ETFs, you should learn the pros and cons of these unique securities.
Preference in bankruptcy
Less market risk than common stock
Interest rate risk
No voting rights
Here are the pros of buying preferred stock ETFs:
- Higher dividends: Compared to common stock, preferred stock will usually pay greater dividends.
- Preference in bankruptcy: Preferred stocks are ahead of common stocks (but behind bonds) in order of liquidation if there is a bankruptcy proceeding.
- Less market risk than common stock: Dividend payments are fixed, and price changes are not as pronounced, when compared to common stock. Both of these features make preferred stocks less risky.
Here are the cons of investing in preferred stock ETFs:
- Interest rate risk: Since preferred stock is interest rate sensitive like bonds, they are not the best types of investments to hold when interest rates are rising. This is because the price falls when interest rates are going up. However, common stock can gain price in a rising interest rate market.
- No voting rights: Unlike common stock, shareholders do not receive voting rights with preferred stock.
- Minimal growth: The tradeoff for low market risk and fixed dividend rates is that preferred stock produces little to no price gains for investors.
How to Assess and Buy Preferred Stock ETFs
If you're looking to invest in preferred stock ETFs, there are a couple features to focus on. The best preferred stock ETFs will be true to their stated objective, meaning that the majority of holdings will consist of preferred stocks (or they will closely track an index of preferred stocks). Since most preferred stock ETFs track the same or similar benchmark indexes, low costs become one of the main features to look for when trying to get the best deal for your money.
You should also look for high assets under management and a long track record of performance. If you’re looking for yield, a high current yield, such as the SEC 30-day yield, is a must.
With those criteria in mind, here are a few preferred stock ETF options in 2021:
- SPDR Wells Fargo Preferred Stock ETF (PSK): Considering all of the qualities that make the best-preferred stock ETFs, PSK may be the best overall. With a solid current yield of 5.29% and a low expense ratio of 0.45%, PSK offers a good combination of income and low cost that preferred stock investors seek. PSK tracks the Wells Fargo Hybrid and Preferred Securities Aggregate Index.
- Invesco Preferred ETF (PGX): With assets under management near $5 billion, PGX is one of the largest preferred stock ETFs on the market. Higher assets can translate to more stable prices through greater liquidity. The current yield for PGX is 5.19% and expenses are 0.51%. PGX tracks the ICE BofAML Core Plus Fixed Rate Preferred Securities Index.
- Global X Superincome Preferred ETF (SPFF): If you’re looking for high yield, SPFF may be the fund for you. Its current yield of 5.53% is higher than most preferred stock ETFs and the expense ratio of 0.58% is attractive. However, assets are on the low side at just $220 million.
The Bottom Line
Preferred stock ETFs can be a wise choice for investors who are looking for a way to diversify a portfolio designed for income. The combination of high dividends and lower market risk, compared to common stock, can be attractive for conservative investors. However, long-term investors looking for growth may want to look elsewhere for the best ETFs for their portfolio.