Originally posted: June 19, 2012
I came across a special report on retirement income last week during my daily reading regimen. I was surprised by one particular article on ways to boost your retirement income. The recommendation was for preferred stocks—an area I know well and a choice that makes sense in the right environment. But now is not that time.
The hook for preferred stocks is the current yield of 6%. But one catch, as the article correctly points out, is that preferreds are lower on the food chain than bonds. There’s more risk of not getting paid if the company can’t make rent. Another risk I want to point out to you that is not covered in the article is the maturity risk.
You may never hold the preferred until maturity—they go out a long, long time. If you’re 65 or 75 years old, you’re buying the payment or the 6% yield. Your plan is that it gets paid in perpetuity. You may not be around when it matures. But the maturity risk is real during your holding period.
The law of the relationship between preferred prices and interest rates is like the law of gravity. If interest rates go up, then prices must come down. It has been my experience that once prices begin their decline, the same is true for investor risk tolerance. If you can’t stomach the decline, you may be forced to sell at a loss much greater than the 6% yield you were so pleased about today. Remember, interest rates can’t go below zero. They’re at secular lows today. And if rates go up, then, as I explained, prices will no doubt go down.