Preferred stocks can offer investors plenty of attractive income — and do so at a favorable tax rate — but they should proceed with caution before adding them to their portfolio. Preferred stocks are hybrid assets, combining attributes of bonds and equities, and their issuers include banks and utilities . They trade on exchanges just like stocks, but they also pay investors a quarterly stream of steady income.
In addition to touting attractive yields exceeding 6%, preferred stocks can also offer investors tax-advantaged income: Their coupons generally — but not always — get the same tax treatment as qualified dividends , levied at a rate of 0%, 15% or 20%. Meanwhile, corporate bond interest payments are subject to ordinary income tax rates, which can be as high as 37%. But investors who find these tax-advantaged yields tempting will need to contend with preferreds' unique risk profile.
"The preferred market is very complex," said Ken Waltzer, certified financial planner and senior vice president at Wealth Enhancement Group in Los Angeles. He said these securities make up no more than 15% of his clients' fixed income allocation. "There are lots of caveats," he added.
Unique features Preferreds that are offered to retail investors have a fixed par value of $25. The coupons these issues pay can be fixed for their entire term, or they can be "fixed-to-floating," meaning that after a certain period, the rate becomes adjustable. These instruments have long maturity dates �.
