Many investors compare preferred stock and high-yield bonds when looking for investment options that provide income and potential stability. Preferred stock provides investors with steady income from fixed dividend payments, but doesn’t offer much growth. High-yield bonds, on the other hand, offer higher interest rates and returns because they are issued by companies with lower credit ratings that have to compensate for the increased risk.
If you want to add preferred stock or high-yield bonds to your portfolio, a financial advisor could help you to analyze the benefits and risks.
What Is Preferred Stock?
Preferred stock is a type of equity security that combines elements of both stocks and bonds. Preferred stockholders receive dividends at a fixed rate, which are typically paid out before any dividends are distributed to common stockholders. This makes preferred stock attractive to investors seeking regular income.
You should also note that if the company is liquidated, preferred stockholders have a higher claim on the company’s assets, after debt holders. However, preferred stock typically does not provide voting rights, which limits shareholder influence in company decisions.
Preferred stock may be callable, meaning the issuing company can repurchase the shares at a predetermined price after a certain date. Some preferred stocks are also convertible, allowing holders to exchange their preferred shares for a specified number of common shares under certain conditions.
What Are High-Yield Bonds?
High-yield bonds, also referred to as "junk bonds," are debt securities issued by companies with lower credit ratings, typically below investment grade as determined by credit rating agencies like Moody's or Standard & Poor's.
These securities can offer higher interest rates than investment-grade bonds to compensate for the increased risk of default. The higher yield can provide a substantial return, but it comes with the trade-off of increased volatility and the possibility of the issuing company failing to meet its debt obligations.
Preferred Stock vs. High-Yield Bond
You should know the key differences between preferred stock and high-yield bonds before investing. Note these four common similarities to help you choose the option that best fits your overall strategy and portfolio needs:
- Income generation: Both offer regular payments-dividends for preferred stock and interest for high-yield bonds. This consistent income stream is a primary reason investors choose these assets.
- Priority in liquidation: Preferred stockholders and high-yield bondholders have a higher claim on a company's assets than common stockholders if the company goes bankrupt. This makes them less risky compared to common stock.
- Less volatility: Compared to common stock, both preferred stock and high-yield bonds generally experience lower price volatility, although they are not immune to market fluctuations.
- Fixed payments: Both securities typically offer fixed payment structures, providing predictability in returns, which appeals to conservative income-focused investors.
And here are five key differences to keep in mind:
- Equity vs. debt: Preferred stock is an equity security, meaning holders own a stake in the company, albeit usually without voting rights. High-yield bonds are debt securities, where investors are creditors rather than owners.
- Risk levels: Preferred stock is generally issued by stable companies and carries lower risk. High-yield bonds are issued by companies with lower credit ratings and a higher likelihood of default.
- Payment obligations: Dividend payments on preferred stock can be suspended if the company faces financial difficulties. In contrast, bond interest payments are legally required unless the company defaults, making them more reliable in regular payout terms.
- Market sensitivity: Preferred stock values can fluctuate like common stock, influenced by the issuing company’s performance and overall market conditions. High-yield bonds are more sensitive to interest rate changes and the creditworthiness of the issuer.
- Capital appreciation: Preferred stock may offer some potential for capital appreciation, similar to common stock, especially if the company performs well. High-yield bonds are typically focused on income, with less opportunity for price appreciation.
Which Should I Invest in?
Choosing between preferred stock and high-yield bonds depends on what you want from your investments. If you prefer stability with steady returns, preferred stock may be a good choice, as it offers regular dividends and comes from stable companies. If you’re open to taking on more risk with the goal of earning higher returns, high-yield bonds offer higher interest payments to offset the greater risk of default.
Bottom Line
Preferred stock and high-yield bonds offer income but differ in risk and structure. Your choice depends on whether you want steady income with lower risk or higher returns with greater risk. A mix of both can also help balance your portfolio. Understanding these differences will allow you to align your investments with your strategy.
Tips for Investing
- A financial advisor can help you analyze investments and manage your portfolio. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to determine how much your investments could grow over time, SmartAsset's investment calculator could help you get an estimate.
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