Preferred stock is considered to be a hybrid security with investment features similar to common stock and bonds issued by the same company. Preferred stock provides a promise that it will pay to investors annual dividends stated as a percentage of par value before common stock is paid any dividends. A preferred dividend can be participating means the preferred share holder’s dividend can increase above the stated rate, if earnings are sufficient to pay common shares received their portion of declared dividends. While the preferred stock has a preference over common stock with respect to dividends, it also has preference in the liquidation of company assets over common stock should a bankruptcy be filed. The overall investment characteristics of preferred stock make it an ideal investment for risk adverse investors with a need for income and growth potential.
Preferred stock is predominately issued by financial institutions. Preferred stock markets are dominated by bank, insurance company, and other financial companies because preferred stock and hybrid preferred stock help meet regulator imposed capital requirements. As a result of the capital requirements, roughly 70% of preferred issues belong to bank, insurance, and other financial companies. An additional 10% originates from REIT/Real Estate issuers, and the remaining 20% is divided relatively evenly among utilities, consumer corporations.
Many investors value the investment characteristics of preferred stock and accumulated preferred shares in their portfolio until securities concentration increased in these sectors. As a practical matter, investor portfolios became concentrated in preferred stock which reduced the overall level of diversification, thus increasing risk. The exposure to the financial sector increased risk and was evident throughout the 2008-2009 financial crisis, as the value of portfolios concentrated in preferred stock proved both highly volatile and highly correlated with the mortgage crisis.
It is important to determine what percentage of your investment portfolio should be invested in preferred stocks, and which type of preferred stocks based on your investment objectives, risk tolerances and investment time horizon.
Investors are advised to seek competent financial, tax and legal advice concerning the decisions they make with their investments. Klayman & Toskes, P.A. can provide you with a free consultation concerning any securities industry violations related to the handling of your investments accounts by a full-service brokerage firm or registered investment advisor.
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