The Preferred Way to Make Money

Today on Money Girl: My Preferred Way to Make Money

Listener Paige from San Diego calls in: “I am looking for a good alternative to CD’s and Money Markets. My local bank is offering 2.5% on a one year CD and 1% in the savings account. I need the income to help pay my bills, but these low rates are not cutting it. What can I do? Thanks for your help and I love your show!”

Paige: Don’t you just hate that? 2% on my hard earned money just isn’t going to cut it either. Let’s tackle this problem together…

The Rule of 72

Back in episode 26 of Money Girl there was a little shortcut discussed which is used in finance known as the “Rule of 72”. It states that dividing 72 into the interest rate you are earning will tell you how many years it will take for money to double. So if you have money invested in an account earning 2% and reinvest the income, it will take 36 years to double. Yuck! That is not going to get us anywhere fast, especially when inflation is running at 4% and taxes will take a piece out of it as well. If the bank pays you even as much as 4%, you still are swimming upstream!

What Are Preferred Stocks?

Here is The Disciplined Investor’s “Preferred” way of investing for income. This a strategy that we use in our client’s portfolios regularly and offers a good deal of safety that is designed to help you with your investing sleep-factor. In fact, this idea helps you earn money while you are sleeping. Now that is is my kind of investing. It offers yields approaching 7 or 8 percent and even offers some tax advantaged. You like that don’t you! (I see you smiling…)

But, before I provide you today’s tip, remember that I said the word safety, not guaranteed. There is a difference here. Remember, all investments carry some degree of risk and you need to consult with your financial advisor and do your homework before making any investment decision.

While I am sure you have probably heard of Preferred stocks before, did you ever look into what they can actually offer? These days, with all of the uncertainty surrounding the market and the fact that interest rates on most interest-bearing investments is low, this is a great way to earn a decent level of income on a low-risk investment. Preferred stocks are a class of stock similar to the common stocks issued by public companies but usually pay dividends at a much higher rate than the common stock. While it is a form of ownership of the company, the difference is that preferred stockholders often do not have the voting privileges that common stockholders do. In fact, most preferred stockholders have no voting rights at all.

What Are the Different Types of Preferred Stock?

Now to complicate matters even more, there are several different types of preferred stock which include callable, convertible, cumulative, participating, and prior. Callable preferred stock is where the issuer, otherwise known as the company, has the right to call in the stock. When stock is “called in” it is redeemed by the issuing company at a predetermined price and retired. Thus you could lose your stock instantly without warning. Of course you will be reimbursed for it; but that could be at a lower price than what you paid. Convertible preferred stock is the type where the shareholder has the option to convert the preferred share into common shares after a certain period of time. Some companies also reserve the right to convert the stock themselves in which case you will end up with common stock without your input. This could be good when a stock is growing fast, but usually will not provide the same level of income since it is geared for income AND growth opportunity.

Cumulative preferred stock act in a similar way to what you see with basic preferred stocks except for the difference that if a company suspends dividend payments for any period of time, for any reason, then the preferred shareholders must be paid first when the dividend is reinstated. In fact, they will get repayment for the dividends they missed as well, before any other category of stock is paid a dividend.

Participating preferred stock is the type that receives the normal preferred stock dividends plus an additional dividend which is predetermined based on each company’s individual parameters. Lastly, prior preferred stock is preferred stock which has a higher claim on the assets and dividends of the company than any shareholders.

How to Find the Right Preferred Stock

OK, you are now experts on the various types of Preferred Stocks. Now, in order to actually invest in preferred stocks, you have to know the quality rating, the company behind the dividend, the tax status and the yield. You also need to know where to find this information. I have put together a list of resources and a special list of preferred stocks you may want to take a look at to learn more about what they offer. Got to the show notes at the bottom of this page for these, and for more tips of my Preferred Way to make Money.

Remember, investing in preferred stock, like anything else, has advantages and disadvantages. You get more dividends than a common stock and it has increased liquidity over bonds but your dividends can be suspended, you have limited or no voting rights and stocks are subordinate to bonds and other debt if the company were to go bankrupt. You simply have to weigh the pros and cons when deciding if you want preferred stock versus common stock.

Cha-Ching …and that’s all for now. Courtesy of Andrew Horowitz, QDT’s The Winning Investor and guest host for this episode of Money Girl’s Tips for a Richer Life. For more great tips on investing, pick up a copy of my book, The Disciplined Investor, online or at fine bookstores. And, one of those copies is going Paige for her great question that helped with today’s show.

Thanks for tuning in to “Money Girl”. If you have a question or comment, email it to money@quickanddirtytips.com“>money@quickanddirtytips.com.

Resources: Quantum Online , Preferred Stocks for A Volatile Market , A Primer on Preferred Stocks , WikiPedia Preferred Stocks

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