The market isnt doing fixed-income investors any favors right now. But one of my favorite fundsin one of the best cash flow niches in the marketis delivering a gaudy 6.6% yield at todays prices.
And it does that by holding some of Wall Streets most boring, stable and dependable securities.
How can we bank this 6.6% free lunch when 10-year Treasuries still pay less than 2%? By tapping into an income stream that most individual investors rarely think about: Preferreds.
The Power of Preferreds
If we wanted to own a piece of a company, say JPMorgan Chase (JPM), wed go out and buy a few shares of JPM. Those particular shares are whats known as the common stock of this mega-bank.
But look just past the common stock, and thats where youll find preferreds.
Corporations will sometimes issue preferred stock as an alternative to issuing bonds to raise cash. These preferreds generally pay dividends that receive priority over those paid on common shares (a nice benefit during brittle economic times like these).
Another nice benefit? Sometimes, preferred dividends are cumulativeif any dividends are missed, those dividends still have to be paid out before dividends can be paid to any other shareholders.
But better still, these dividends are almost always juicier than the modest dividends paid out on common stock. A company whose commons yield 2%, even 1%, might still be doling out 5% to 7% to their preferred shareholders.
The downside to preferreds is that they behave a lot more like bonds, trading around a par value over time. But the chart above is missing one key componentthe dividends. Once you factor in preferreds juicy income, you get extremely attractive total returns with a fraction of the risk of commons.
Just remember: Preferred stock can collapse the same way common stock can, and in fact, some preferreds went the way of the dodo during the 2007-09 financial crisis. Thats why second-level investors like us do the smart thing and buy preferred fundslocking up those 5% to 7% yields while defraying our risk across dozens, even hundreds of issues.
Let me show you what I mean.
The Best, and Worst, Ways to Invest in Preferreds
Again, the 10-year T-note is yielding 1.7%, but like most people, we buy our bonds via funds. So lets say we buy a medium-term bond fund like the iShares 7-10 Year Treasury Bond ETF (IEF) were actually getting less than that, at a meager 1.4%.
That means if you sunk a million dollars into IEF, youd be generating a meager $14,000 in annual income.
Sad.
If we go out even further, say 20-plus years, with the iShares 20+ Year Treasury Bond ETF (TLT), were taking on quite a bit more risk just to get bumped up to a 2.2% yield right now.
Now, lets see what happens when you upgrade yourself to preferreds:
The iShares Preferred and Income Securities ETF (PFF), Invesco Preferred ETF (PGX) and First Trust Preferred Securities and Income ETF (FPE) are the three largest preferred exchange-traded funds on the market. And as you can see in the table above, youre looking at an immediate upgrade in yield over Treasuries and corporates, and in the case of PFF and PGX, youre easily outyielding junk bonds, too.
All of these funds offer similar exposure, so well use PFF as an example. The ETF holds more than 500 preferred securities, the majority of which (60%-plus) come from financial institutions such as Wells Fargo (WFC) and Bank of America (BAC). This is par for the course, as is large weightings in industrial and utility preferreds.
Were getting built-in diversification and a decent yield for all of 0.46% (the best of the trio, by the way). And across all three, were enjoying superior performance to a standard bond index.
Preferreds Have Doubled Up Basic Bonds
And we can do even better by thinking smaller.
Lets Earn 6.6% With Preferreds
If youve heard of a high-yield ETF, chances are theres a better CEF version just waiting to be discovered.
Closed-end funds command a mere fraction of the market of exchange-traded funds. Theyre typically actively managed, they can be more complex, and they can charge higher fees, which scares off many beginner investors.
But if we choose our managers wisely, theyll more than make up for their costs.
Our mystery 6.6% yielder is none other than the Flaherty & Crumrine Dynamic Preferred and Income Fund (DFP). At about $570 million in assets, DFP is a mere fraction of the ETFs we just discussed. And because its in the unsexy world of CEFs, its not on your typical CNBC guests radar.
Too bad for them.
Basic Preferred Funds Eat DFPs Dust
DFPs managers have put together a portfolio of roughly 170 holdings that, like most preferred funds, is heavy in financials, at 86% across banks, insurers and other sector names. Most of the preferreds are clustered around the investment-grade line, with 44% in Baa-rated (the lowest investment-grade rating), and 39% in Ba-rated (the highest junk rating).
You also get some international diversification, which doesnt hurt; the U.S. makes up 70% of holdings, but you also get exposure to the U.K., France, Australia, even Mexico.
Flaherty & Crumrines managers are what set DFP apart from preferred ETFs, which are almost all index-based. Here, management has an advantage in that they can exploit deep values in the preferred space that the rules-based indexes just simply cant do anything about.
But also powering DFPs high yield and strong performance is managements ability to use leverage to amplify its bets. At the moment, DFP uses a high 33% leveragewhich results in more volatile returns than its ETF peers, but its hard to complain about the results.
If a 6.6% Yield Sounds Great, How About 8%Paid MONTHLY?
Alas, would-be buyers of DFP have been cursed by the funds success. It has become so relatively popular of late that its actually trading at a whopping 12% premium to its net asset value.
This is a great fund, with great people at the helm. But paying $1.12 for a bucks worth of assets is a quick way to handicap your own returns on new money.
Fortunately, DFP can wait. Because many of the other picks in my 8% Monthly Payer Portfolio are trading at the right price, and the right yield, right now.
In fact, today, you can secure a portfolio yield of more than 8% and have those dividends paid out to you each and every month.
Just like DFP, many of the picks in my 8% Monthly Payer Portfolio leverage the power of steady-Eddie holdings like preferreds to generate massive yields and shockingly aggressive performance. That allows us to double our money much more quickly than most investors do through popular ETFs.
The dividends youll find here are truly life-changing: drop $500K into this powerful portfolio now and youll kick-start a $40,000 income stream. Thats about $3,300 a month in regular income checks!
Now is the time to get in, while you can still do so at a bargain. Click here to get everything you neednames, tickers, complete dividend histories and moreinstantly.