Increasingly popular preferred stocks still misunderstood
By HELEN HUNTLEY
Published January 18, 2004
Preferred stocks have soared in popularity, but they remain widely misunderstood by investors who buy them to boost the yields on their portfolios.
Quite naturally, many investors' eyes light up when they see preferred stocks listed in the newspaper stock tables with generous yields. Take, for example, TECO Energy preferred shares (known as TECO Capital Trust II) that recently have been yielding about 14 percent.
"I don't see TECO going bankrupt in the near future," one reader wrote me. "Is there a risk involved that I'm missing?"
The answer is "Yes." The investor who buys that particular preferred stock will collect the generous dividend, but most likely end up losing principal.
How can that be?
Preferred stocks are issued with a variety of conditions attached to them.
Many preferred stocks can be redeemed early by the issuer. If you pay a premium when you buy the shares, you lose principal if they are redeemed at face value. In addition, many preferred stocks are convertible into common stock. If the common stock declines in value, as TECO's stock did, that's bad news. Although conversion is often optional for investors, it will become mandatory for those who hold TECO's preferred shares.
If you still own TECO preferred stock on Jan. 15, 2005, you will have to swap those shares for TECO common stock, receiving between 83 and 95 shares for each 100 preferred shares you own. The value of that swap fluctuates, but recently 100 shares of preferred were trading for $1,740 and 83 shares of common for $1,242. It is likely that the price on the preferred shares will move closer to value of the equivalent in common shares as the conversion date approaches. The biggest losers will be those who invested in the initial offering, paying $2,500 for 100 preferred shares when they were issued three years ago with their 9.5 percent coupon.
"Many people jumped at this when they saw the income TECO was offering," said Greg Ghodsi, a broker with Robert W. Baird & Co. "If the TECO common stock stays the same or goes higher, they win. But instead it went down."
Q. We lost more than $100,000 in mutual funds, so my wife and I took our money out and put it in CDs. We haven't been making much money, but we are not losing any either. Now that stocks have been going up, the wife keeps hinting about going back into mutual funds. We have $500,000 in savings and monthly income of about $2,500 from pension and Social Security. I also have a part-time job that pays about $5,000 a year. We live a very frugal life and have very few expenses. We own a fairly new car and a mobile home in a very nice park and have no debt. I am 68 and my wife is 65. Neither of us is in the best of shape. What's your opinion on whether we should get back into funds?
Stick with safe investments that are comfortable for you. Stock market investing is for people who can stay the course. If your nervousness prompts you to pull out when the market goes down and get back in after it has gone up, you'll never make any money.
Furthermore, there is no need for you to take any risk. It sounds as though you have enough money to meet your needs.
Q. I have savings bonds that are now 30 to 40 years old that I need to redeem. Can I redeem them into HH bonds to continue to defer taxes on the interest? Or is there some other way to avoid paying taxes when I redeem them? My deceased spouse is the beneficiary on most of the bonds. Do I need to get them reissued?
You are right that you need to redeem your bonds. Nearly all savings bonds issued 30 or more years ago have stopped earning interest. Some issued in 1964 and 1965 are eligible to earn interest for 40 years, but even their time is running short.
It is still possible to exchange E and EE bonds for HH bonds, deferring taxes on the interest, but you will only earn 1.25 percent interest if you do. If this appeals to you, act now, because the government plans to discontinue HH bonds sometime this year.
If you cash the bonds, you will owe income taxes. The only way I know to offset the extra income is to donate the money to charity and claim a charitable deduction on your tax return. However, that only works if you itemize deductions.
There is no need for you to have your bonds reissued before you redeem them. In fact, bonds that have stopped paying interest cannot be reissued.
- Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731.