Does the stock market overwhelm you? Do you want a more predictable way to invest in stocks? I could have the answer for you- Preferred Stocks. Once you understand the basics of preferred shares, investing will hook you. The hardest part of investing in preferred shares is finding them.
In “Stock Market Investing 106: High-Yield Alternative Investments,” I listed prefers (abbreviation) as a high-yield way to juice the returns of your stock market portfolio. To get the most out of preferreds, you will need to understand what they are and when to invest in them to get the highest possible yields.
I had always heard about prefers but had never looked into what they were. Then, the book “The Billionaires Secret” dropped into my lap. The book explained what preferreds were, from start to finish. Ever since then, I have gained a passion for preferred. Look at my preferred portfolio below.
I built my entire preferred stock portfolio after I read “The Billionaires Secret.” In fact, I just received a nice $11.69 dividend from the preferred stock GLOP.C. Not only do I have some excellent capital appreciation on this stock (31%), but I am also getting a 15% dividend yield. Hopefully, after you read this series, you will have the same kind of success. However, I still
recommend reading “The Billionaires Secret.” Let’s begin our deep dive into the world of Preferred Shares.
5 Takeaways from “Step by Step Bond Investing”
Preferred Stock (or preferred shares, prefers, preferreds) is a class of equity stocks that hold a senior position to common stocks. Before we go further, we need to discuss the difference between equity and debt. Knowing the difference between these will help you in the investing world and also the business world.
A company can raise capital (money) in distinct ways, taking on debt (a loan) or offering equity (partnerships, stocks). When a company creates a debt obligation, they usually take out a loan from the bank or a loan from investors. Investors pay back the loan in the form of bonds. Bonds pay interest and typically have a fixed term and interest rate. Debt investors do not share in the profits of the company.
Equity is different because the company is giving up control of the voting and the profits. Companies can offer out shares of their company to raise capital from the general public- this is called the initial public offering. Those shareholders now hold voting rights within the company, and when the company becomes profitable, the shareholders may share in the profits via dividend payments.
I want to ensure everyone understands the difference between debt and equity, so I want to give an example of a house. If I were starting a rental business with one house, I would need to raise capital. Let’s say that the house cost $500,000. I could gather investors and offer debt via bonds to pay for the house. They would get a fixed rate and a selected date for me to pay them back. It would be passive income. If my business failed, investors could always sell off the house and their money returned- so their risk wouldn’t be too high. Bonds don’t usually pay a high return because they are not considered risky investments.
Cash Flow 104: Create Your Long Term Strategy
If I wanted to expand my business, I could raise capital by offering equity in my company. When I am looking to expand my business, I could offer shares to raise another $500,000. This money may not be tied directed to another home. The investors may not know what I was buying and would be investing in the business and the management team. Their risk is higher, so they would share in the profits via dividends. They would also have voting rights for certain aspects of my business.
My business now has raised capital via debt and equity. Bonds (debt) pay interest, and stocks (equity) pay dividends. Understanding the difference is vital because if things go wrong with my rental business, the capital instrument will come into effect. During liquidation, debt holds a higher position on the chain of command.
If my rental business failed, the bondholders would hold a senior position to liquidated assets. From there, the shareholders would receive whatever is leftover. It is important to note that big businesses have tons of different debt instruments ahead of common stocks. I won’t get into them here; just understand that senior secured debt, unsecured debt, etc., all hold a higher position on the chain of liquidation than common stocks.
The $30,000/month Cash Flow Retirement
I had to go that deep into debt vs. equity because this is a significant factor in the appeal of prefers. Preferred Shares hold a senior position than common stocks. Therefore, during liquidation, the preferred shareholder may get a payout before common stocks. However, remember there may be lots of debt to pay off before getting to the preferred shareholders.
I also said that bonds have a fixed rate of return and maturity date. Upon maturity, bondholders will receive the face value of the bond. For example, if I bought a $25 bond with a term of 5 years, I would receive interest payments for five years and then be paid back my $25 at the end of the period.
Preferred Shares act like bonds; however, they pay dividends (not interest). When you buy preferred shares, you know the face value of the preferred. Since they trade on the stock market, they can sell at deep discounts. If a $25 preferred is trading for $18, and the company calls it (paid back), you would receive the full $25. Dividends are treated more favorably on taxes than interest as well.
Preferred shareholders, however, do not have voting rights like their common stock brethren. Having no voting rights could be a massive deal to some people but not to others. Also, common stocks can appreciate an unlimited amount and preferred tend to trade close to par (face value). Common stocks also can receive dividend increases over the years; preferred shares always pay their initial dividend amount.
Municipal Bonds: Tax-Free Goodness
Speaking of dividends, all preferred shareholders must receive their dividends before common stockholders can receive their dividends. So on the dividend payout chain of command, preferred are higher on the chain. Being higher may come in handy during an economic downturn when a company decides to cut the dividend on common shares. Thus, preferred shareholders may still be getting their payouts.
Here is a list of the differences and similarities between common stocks and preferred shares. I took this from “The Billionaires Secret.”
This article was a more extended introduction than I expected; however, you will need to understand the difference between debt and equity. Also, the value of holding bonds and shares is vital to building a complete portfolio. Knowing this key difference will help you allocate preferred shares in your dividend portfolio. You may also want to buy some corporate bonds after reading this.
In Preferred Shares 102, we will discuss what to research in preferred shares before you buy. There are very complex preferreds, and there are also terms that we want specifically to look for in the world of preferred investing. It does get deeper and much more profound, but we will learn how to simplify purchasing and increase our dividend yields. Stay tuned.
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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