For many investors, shopping for preferred stock shares feels like being a teenager in a used- car lot. The deals look like they're too good to be true -- and they often are. But some savvy investment pros are plying a new strategy to take advantage of the shares, while lowering the risk of getting stuck with a lemon.
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Preferred shares are something of a hybrid between stocks and bonds. The share prices don't fluctuate as much as the prices of common stock for the same company -- and they pay dividends that are often considerably more generous than those on common shares. In fact, such yields (recently averaging 7 percent, at a time when the broad bond market paid 3 percent) helped persuade Robert Wasilewski, a Glenelg, Md., financial planner, to divert about 5 percent of his clients' holdings to preferred shares from bonds.
But here's where the asterisks come in: Preferred shares are often complicated to figure out and expensive to trade -- which is why many planners are turning to exchange-traded funds that bundle preferreds rather than buying the shares outright. Investors poured more than $1.5 billion into the largest of these products, the $7.4 billion iShares S&P U.S. Preferred Stock, in 2011. While the ETF costs $48 in fees annually for every $10,000 invested (plus brokerage commissions), that's a lot cheaper than buying the shares themselves, which can run $200 for every $10,000 invested, says Harris Private Bank Chief Investment Officer Jack Ablin.
Of course, there's a reason why preferred yields are so lofty now. Nearly three-quarters of issuers are financial firms -- a sector under siege from the crisis in the euro zone, the lousy real estate market and much else. For Ablin, that's more incentive to spread out the risk by way of an ETF. "And if things go sideways," he says, "you've still got a nice dividend."
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