If you just read the title, you probably think what weird securities to compare. Preferred Shares trade on the stock market, while the US government sells treasury bonds.
However, these assets have an inverse relationship hidden from many people. It all starts with the investor’s chase for yield.
Yield is everything. As investors, we all seek to get a return on our investment. We can put a percentage on this return in most cases, which we call yield.
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With dividend stocks, we call it a dividend yield. With bond investing, we call it interest. Real estate, we call it cash-on-cash. Whatever the name, investors seek to grow their income.
Therein lies the rub; we want the highest possible yield with the lowest potential risk. This is where preferred shares and treasury bonds compete for our dollars.
In this article, I will reference preferred shares from highly rated companies. Typically, I invest in preferred shares with a junk rating that pays high yields (9% or higher.) This article refers to preferred shares around 3-5%.
Competing for our dollars. Treasury bonds are potentially the safest instruments an investor can buy. In the 1970s, treasuries reached yields of over 14%. Inflation was crazy high, of course, but it was an excellent time to be a saver.
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Whether institutional or retail, investors would love to invest most of their money in treasury bonds. However, what happens when the Federal Reserve lowers its interest rates to zero?
That’s right, the rates on treasury bonds decrease to near nothing. Who wants to purchase a 30-Year treasury with a 2% coupon (interest rate)?
Chasing yield. In a zero-rate environment, investors will chase yields that could be considered safe. This is where preferred shares from highly-rated companies come into play.
As a reminder, preferred shares are higher on the hierarchy than common shares but less than bonds. If a company gets wiped out, the repayment order goes like this: debt, preferred shares, and common shares.
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Please check my series on preferred shares to catch up on these wonderful instruments.
- Preferred Shares 101: Getting Started with Preferred Shares
- Preferred Shares 102: Terminology is Important
- Preferred Shares 103: The Rule of 72
- Preferred Shares 104: The Search for Shares
- Preferred Shares 105: Long-Term Preferred Strategy
Great companies, low yields. Some fantastic companies offer preferred shares; however, they are usually low-yielding. One of my favorite common stocks is Public Storage.
Public Storage (PSA) is a blue-chip REIT that pays a decent dividend for a growth-style stock. They have a preferred share (PSA.P) that has a coupon of 4%.
If you bought the preferred at par value ($25), you would get a 4% dividend yield. This gives me an annual dividend of $1 or a quarterly dividend of $0.25.
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The inverse relationship. When treasury yields are low (say 2%), investors flock to highly-rated preferreds like PSA.P, meaning they may be willing to pay over par value.
Suppose investors pay over $25 for the same $1 dividend, decreasing their dividend yield. Let’s say they paid $25.50 for PSA.P, meaning their yield is 3.92%
As more investors flock to these preferreds, the dividend yields continue to decrease. This happens until treasury yields start to increase.
As treasury yields, mainly the 10-Year Note, begin to reach 3%, people sell their preferreds and flock to the safest products, the US Government.
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Awareness matters. I was unaware of this dynamic of these two securities because I usually look at high-yield preferreds. But it was brought to my attention by my favorite author on Seeking Alpha, Rida Morwa.
Sure enough, when treasuries rose, I saw terrific deals on preferreds from Public Storage, AT&T, and Bank of America.
These are solid companies with outstanding ratings. Thus, purchasing these preferred with a yield of 5% was an incredible steal.
Because I own Public Storage common stocks in my dividend growth portfolio, I went with their preferred. I didn’t buy too many because I was buying even higher-yielding products elsewhere.
What I bought. What a great day to be an investor. I am a high-yield investor, so 5% yields are not my cup of tea. But to get a 5% yield from Public Storage is impressive. The common stock yields roughly 2%-2.5%.
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As you can see above, I bought five shares with an average price of $18.86. This gives me an effective dividend yield of 5.30%. Plus, I am already experiencing capital appreciation as investors run back to preferred shares.
Be on the lookout. Now that you know about the inverse relationship between treasuries and high-quality preferreds, how do you monitor the situation?
The best way to monitor preferred shares is to buy one of your favorites. When you see that your purchase is in red, it may be a buying opportunity.
For example, now would be a good time to buy shares of Bank of America (BAC) and AT&t (T) preferred shares. As the economy struggles to find its footing, there will be a see-saw between treasuries and preferreds.
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Conclusion. Don’t let the economy get you down. Great investors can make money in any economy and any stock market predicament.
I love buying 30-Year treasury bonds, but the yield is too low at the moment. We are looking at close to 3% for a 30-Year bond. However, I am getting 5.30% from PSA.P, along with a chance for capital appreciation.
I will be a buyer of 30-Year bonds when they reach 4%. That doesn’t seem to be the case for the next year or so.
Either way, I never sell my products. I just continue to add to my portfolio at the best possible yields. I am monitoring the economy and prices daily, getting great deals.
I can use my dividends to buy more yields. What a great life!
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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. All Right Reserved Military Family Investing
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