Preferred Shares as a Tool for Portfolio Diversification
A preferred share is an ownership class in a company that offers investment income. It is a type of hybrid security that is senior to common stock.
Functions and Features of Preferred Stock
The main features of this product are redemption price and date, dividend, issue price, and ticker. It has fixed income and equity features and often has no maturity date. The yields are tax-efficient in that investors receive dividends which are subject to a more favorable taxation that other securities. When it comes to investment strategies, the main reason to invest in stock is portfolio diversification. Investment income is another reason. This is the preferred solution of investors who are looking for products traded close to their par value. Low volatility is another reason to invest in preferred stock.
Common vs. Preferred
The main difference between them is that the former carry voting rights while the latter do not. There is a separate class – convertible stock – that allows shares to be converted to common stock. The degree to which holders can claim ownership over earnings, profits, and assets is another difference between the two classes. While preferreds are subordinate to bonds, holders have a greater claim compared to the common type. This means that holders are entitled to receive dividends first. In case of insolvency or bankruptcy, they are also paid first provided that the assets have been liquidated, and bondholders and financial institutions get their money back.
Types of Products
Investors can choose from different subtypes, including participating, preferred, and adjustable rate. Holders of participating stock, for example, are entitled to receive an additional and set dividend. Other varieties include cumulative and prior shares, the latter being of the highest order or priority.
Canadian Banks Offering Stock
Financial institutions such as the Bank of Montreal, TD Bank, and CIBC offer preferreds. They offer information on payment dates, dividends, redemption price, and other details. The big banks issue stock, and the restrictions, privileges, and designation are determined by the Board of Directors. Other terms and conditions include transfer limitations, retraction rights, and conversion. The issues are usually non-cumulative. Canadian citizens who are paid dividends enjoy a lower level of taxation. A single person or company cannot buy more than 10 percent of any issue as outlined by the clauses of the Bank Act.
Investing in Stock
This is a good solution for investors who are looking for a product with a higher capital gains potential. Preferred shares offer regular income and are considered a safe investment instrument. There are different ways to go about investing. Some banks, for example, feature dividend reinvestment plans whereby the dividend is reinvested in common stock rather than distributed among the holders. This is one way to diversify one's investment portfolio, with the holder owning both types of products. Before making a decision, it is important to check the value because it changes with interest rate fluctuations. When the rate goes up, the price also decreases and vice versa. Once you make a decision on the type of stock, whether convertible or not, the next step is to open an account with an online or traditional brokerage firm. Traditional brokerage firms are a better choice if you are new to investing and need professional advice. Seasoned investors usually opt for online brokers. Note that stock issues may be offered under different ticker symbols even when traded by a single company.