How to Earn a Safe 6% Yield

Alexander Green
by Alexander Green, Chief Investment Strategist, The Oxford Club
Preferred_IU

After a long absence, volatility returned to world financial markets in recent weeks.

That's not a bad thing necessarily. It never hurts to be reminded that stocks and bonds are not cars on a one-way street.

The traffic often reverses - suddenly and without warning.

Many investors - especially income investors - are now wondering where they can earn a decent return with a lower level of risk.

One suggestion: preferred stocks.

Preferreds are often called hybrid securities. They have the properties of both stocks and bonds.

Unlike common stocks, they generally carry no voting rights. But the dividend is fixed - rather than declared - and has priority over the common stock (hence the "preferred" label).

Also, in the unlikely event of a corporate liquidation, preferred shareholders stand ahead of common stock holders (but are secondary to bond holders).

Like common stock dividends, preferred dividends are taxed at the more favorable 15% maximum tax rate (20% if you're in the highest tax bracket) - plus the 3.8% Obamacare surcharge.

That's considerably less than the new top marginal tax rate of 37% on interest-bearing securities, foreign shares and real estate investment trusts.

If you want to be even more tax-efficient, own these in your qualified retirement plan where they will compound tax-deferred.

Preferreds are less volatile than common stocks, but they still bounce around. They fell during the recent financial crisis, for instance. However, they dropped only two-thirds as much as the S&P 500 and rebounded during the recovery.

Because of their fixed payments, preferreds - like bonds - are interest-rate sensitive. When rates go up, prices go down. And vice versa.

Unlike bonds, however, these securities may not mature for as many as 50 years - if ever. (One caveat: If interest rates rise substantially, you could be holding lower-valued paper that a corporate issuer might not redeem.)

Preferreds have less upside potential than common stocks because the issuer typically has certain redemption rights. These generally include a "call" provision, where the company can buy out shareholders at face value five years after the issue date.

But here's the real benefit: Preferreds are currently yielding around 6%. That's higher than what junk bonds yield, even though preferred shares are less risky.

For example, you can get 6% (or better) yields in preferreds issued by solid financial companies like JPMorgan Chase, Bank of America and Capital One Financial.

Safer still, you could own a diversified portfolio of preferreds. Consider an exchange-traded fund (ETF) like iShares S&P U.S. Preferred Stock Index Fund (Nasdaq: PFF), PowerShares Preferred Portfolio (NYSE: PGX) or the riskier PowerShares Financial Preferred Portfolio (NYSE: PGF).

Or consider a closed-end fund like Nuveen Preferred & Income Opportunities Fund (NYSE: JPC) or Nuveen Preferred & Income Securities Fund (NYSE: JPS). Both are liquid, sell at a 7% discount to their net asset values and pay dividends monthly.

The expenses are higher with closed-end funds because they are actively managed and able to use leverage to goose returns. The ETFs have lower expenses and are less volatile (since prices hew closer to net asset values).

Here's the bottom line: With preferred shares, you get an attractive fixed yield, a more secure position than ordinary stockholders get, more favorable tax treatment than with interest-bearing securities and less risk than with common stocks.

They deserve a place in the portfolios of investors looking for income, safety and broader diversification.

Good investing,

Alex

P.S. If you want to learn much more about preferred shares and other lucrative investment opportunities that can maximize your income, minimize your taxes and double your returns (while minimizing risk), click here for a special offer on my monthly newsletter, The Oxford Communiqué. By joining now, you’ll be on your way to living financially free without money worries and concerns.

Thoughts on this article? Leave a comment below.

Fannie or Freddie - Which Do You Prefer?

It was 75 degrees in Baltimore this week - in the middle of February no less - and I'm in a good mood! So, as a valued Investment U Plus subscriber, I'm bringing you two preferred picks today instead of just one.

For his Oxford Communiqué subscribers, Alexander Green lays out the case for holding both the Fannie Mae 8.25% Non-Cumulative Preferred Series T (OTC: FNMAT) and the Freddie Mac 8.25% Non-Cumulative Perpetual Convertible Preferred (OTC: FMCJK) shares.

In the midst of the 2008 financial crisis, the government dumped all of Wall Street's fast-decaying mortgage-backed securities into Fannie Mae and Freddie Mac.

This crippled Fannie's and Freddie's books and destroyed the value of their shares.

So in 2012, the federal government simply seized 100% of Fannie's and Freddie's cash flows. To this day, the U.S. Treasury takes in every last cent of their incomes.

But that's all about to change... Trump and his administration are dead set on rolling back his predecessor's government takeover of Fannie and Freddie.

It hasn't happened yet, but Treasury Secretary Steven Mnuchin has stated, "This is a 2018 issue. We are going to fix it."

My first recommendation is Fannie Mae 8.25% Non-Cumulative Preferred Series T (OTC: FNMAT), Fannie Mae's highest-yielding preferred stock.

Fannie Mae was founded in 1938 to expand the mortgage-backed securities market. While it's a publicly traded company, it is also government sponsored.

Its coupon - the payout rate based on the stock's par value - is 8.25%. But at a current price of about $8, the theoretical yield would actually be a huge 25.7%.

Despite getting a beating over the years, the preferred market for this one is still very liquid. Its average volume stands at about 3.5 million shares per day.

It's at a low price point with plenty of volume... I'd suggest grabbing as many shares as you're comfortable with right now.

Next, I suggest Freddie Mac 8.25% Non-Cumulative Perpetual Convertible Preferred (OTC: FMCJK), Freddie Mac's highest-yielding preferred shares.

Like Fannie Mae, Freddie was created in 1970 to help expand the mortgage market by buying mortgages, securitizing them and then selling them to investors on the market.

Also like its sibling company, it has a coupon of 8.25%... but its actual yield at current prices would be about 25%.

Its price has been crushed since 2008, and it's now trading for about $8.

This preferred is also liquid, with an average volume at about 1.9 million shares per day.

The Freddie Mac preferred stock comes with the option to convert it into common shares. But I don't recommend this.

Keep in mind that with such a high yield, you'll be able to get your initial investment back after a few years from dividends alone.

That's almost guaranteed to beat any potential return from the common shares.

My advice? Buy and hold on to the preferred shares for as long as you can... and simply collect your unending stream of dividends for as long as you'd like.

- Donna DiVenuto-Ball with Alexander Green

Live Twitter Feed