BALTIMORE BEACON — JUNE 2013
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Money Law &
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FUNDS THAT BEAT THE MARKET Small-cap foreign funds have consistently posted larger returns than index funds LOOK BEFORE YOU LEAP If you’re returning to the stock market, buy into stocks gradually, and consider target date and balanced funds ARE YOU A TREND TRACKER? Startup company Motif Investing enables customers to buy groups of stocks that follow a trend
A way to higher returns at moderate risk Readers continue to ask how they can characteristics of both bonds and equities. invest without a great deal of Preferred stocks pay a fixed risk and still obtain reasoninterest, generally at a higher able income. rate than bonds issued by the I have often pointed out that same company. The current investors who need income yield of preferred stocks is cannot expect high income about 6 percent. Corporations from investing in Treasury issuing preferred stock cannot bills, money-market instrupay dividends on their comments and short-term savings mon stock without paying the accounts. Such investments interest due on the preferred preserve capital but do not stock. keep up with inflation. Preferred stock prices genTHE SAVINGS Alternatives that provide GAME erally fluctuate based on their more income include real-es- By Elliot Raphaelson dividend yield, credit rating tate investment trusts and maturity date (where ap(REITs), Treasury inflationplicable). Increased interest protected securities (TIPS), intermediate- rates generally will depress the value of term bonds, master limited partnerships preferred stock, since investors could pur(MLPs) and high dividend common chase new issues of preferred stock and stocks. These provide more income than bonds at higher interest rates. Also, if a the most conservative investments, but corporation’s financial condition or they are certainly are not risk-free. prospects deteriorate, the value of its outstanding securities will fall. Consider preferred stock Corporations that issue preferred stock Another alternative is preferred stocks. are those that require substantial capital. These are more like bonds than a common Most issuers are financial institutions, utilstock. They are hybrid securities with ities and communications companies.
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Not all of these companies have stellar credit ratings. As a result, there is not a large supply of high-quality preferred. For that reason, in order to minimize risks, investors should consider buying a diversified portfolio of preferred stocks through ETFs rather than purchasing individual company shares.
Advantages and disadvantages An advantage of preferred stocks is that they have a low correlation to other fixedprice securities such as TIPS, REITs and MLPs. A major disadvantage, according to Josh Peters, equity strategist of Morningstar, is the risk of recall. Most issues may be recalled within five years. If interest rates go down, the issuer will likely recall the stock. Another disadvantage is there is no guarantee you will receive the price you paid for the stock. With individual bond purchases, at maturity, you will receive the face value of the bond back. Corporate bonds have maturity dates; most preferred stocks do not. Another disadvantage is the lack of an active market. When you do decide to sell, there may be a large gap between the bid
and ask price for an individual security. That is another reason to buy preferred stocks in an ETF. The price of preferred stock will generally not increase when the income of the corporation increases. Income growth will benefit common stock holders. You do not purchase preferred stock in order to obtain capital growth.
Some recommendations Abby Woodham, an analyst at Morningstar, recommends ETF iShares S&P U.S. Preferred Stock Index (PFF), indicating it has the lowest expense ratio of the ETFs at 0.48 percent. Over the last five years, the fund returned an average of 5.5 percent. The return for the last year was 18.2 percent. The current yield is approximately 6 percent. If you hold your account outside of a retirement account, you should consider the tax implications. For example, some preferred stock dividends are qualified, which means that they are taxed at no more than 20 percent. If the dividends are not qualiSee HIGHER RETURNS, page 16