Preferred stocks get bruised when rates rise

Money Talk

Your Money

May 23, 2004|By MATT LUBANKO

I was just looking over some preferred stocks. The yields are around 7 percent. What are some of the rewards and risks? What are some ways I can reduce my risk? Are there mutual funds that hold mainly preferred stocks?

- M.W., Chicago

Preferred stocks can be a desirable tool for yield-hungry investors.

They pay quarterly dividends. They deliver generous yields. They are liquid: Many of them trade on the New York Stock Exchange. And, although they fluctuate in price, preferred stocks rarely move with the same up-and-down ferocity of common stocks.

But preferred stocks can indeed decline in value - and that's a possibility would-be investors have to consider. As pieces of corporate debt (the term "preferred stock" is almost a misnomer), preferred stocks tend to move in the opposite direction of interest rates.

When interest rates fall, share prices of preferred stocks tend to rise. When interest rates rise - as they have since mid-March - preferred share prices generally fall. And, since mid-March, the yield on the 10-year U.S. Treasury note has risen from 3.6 percent to 4.7 percent; preferred stock prices over that six-week time frame that ended in early May have taken a beating.

"This is not an area where you want to overweight the fixed-income portion of your portfolio," said Kurt Reiman, a senior strategist at UBS Financial Services. To "overweight," in portfolio-speak, is to devote a larger-than-usual proportion of your dollars to a certain type of investment.

And those who have recently thrown bags of dollars at preferred stock funds have been burned. The closed-end Nuveen Quality Preferred Income Fund (JTP), for example, lost 15 percent of its value from mid-March to early May. The John Hancock Preferred Income Fund (HPI) fell 13 percent over the same seven-week time frame. The BlackRock Preferred Opportunity Trust Fund (BPP) lost about 7.5 percent of its value from mid-March into early May. A closed-end mutual fund buys and sells stocks or bonds (or preferred stocks in this case) much like the familiar open-end fund, yet the security, like a stock, can be bought or sold at any time the markets are open.

Despite the risks present in preferred stocks, they can be a solid income holding. They are generally safer than dividend-paying common stocks. Preferred stock dividends, when suspended, must be repaid at a later date, unless the company cannot escape from its financial straits. And shareholders - if the company is in really deep trouble - have some of the first claims on assets: after bondholders but before common stockholders.

"Preferred stocks should not be seen as substitute for low-risk holdings such as bank CDs, U.S. Treasuries or money market funds. They are just a tool in a well-diversified portfolio," said Mark Lieb, who manages a $12 billion preferred stock portfolio for Spectrum Asset Management in Stamford, Conn.

My wife and I are parents to a disabled child. We have heard about special needs trusts and how this estate-planning tool can provide for our disabled child after we die. What are some basic points to consider when setting up such a trust?

- D.H., Chicago

A special needs trust, as the centerpiece or offshoot of a will, is a separate entity unto itself.

It has a name. It has a taxpayer ID number. It has a designated beneficiary. It has the power to provide cash for a disabled child, while ensuring that child remains eligible for federal government assistance, said John F. Kearns III, a West Hartford, Conn., attorney who specializes in disability law.

Once you learn more about the basic working parts of a special needs trust (see the or Web sites), it pays to plan before setting one up.

The trust needs money. Would you use life insurance, regular annual cash gifts, or a portion of the assets from your estate to fund that trust?

The trust needs a "trustee" or supervisor. Trustees manage the money within the trust - and make it last. They find the proper care for a disabled child.

The trust should be supported with a "letter of intent," Kearns said. This letter discusses the nature of your child's illnesses or disabilities. It describes what clothing, recreation, foods and therapy your child desires or requires.

While there are many more details involved in creating a special needs trust, the priorities listed above can help you get started, Kearns said.

Matthew Lubanko is a financial columnist for The Hartford Courant, a Tribune Publishing newspaper. E-mail him at

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