Preferred Stock ETFs vs. Bond ETFs: An Overview
Investors in preferred stocks and in corporate bonds have similar motivations. They're looking for a long-term investment with a reasonable and regular return on their money.
Today's investors can choose exchange-traded funds (ETFs) that focus on preferred stocks or corporate bonds. Whether you choose one or the other shouldbe basedon the current economic environment as well asyour investment strategy.
- If you’re looking for high yield, consider a preferred stock ETF. This is especially true in times when interest rates are low. Preferred stock ETFs areconsidered higher qualitythan common stock ETFsbecause of their relative lack of risk. You will have priority over common shareholders for dividends and any claims on assets. However, preferred stock ETFs usually underperform equity ETFs during bull markets.
- Most bond ETFs offer a diversified portfolio of bonds, excellent liquidity, and low expenses.One of the bond ETFs covered below should clearly offer the most long-term potential regardless of how the broader stock market is performing.
Key Takeaways
- Preferred stock ETFs can perform particularly well in comparison with bonds when interest rates are low.
- Bond ETFs can offer competitive long-term returns regardless of the movements of the stock markets.
- Both can offer steady income to the investor with very low costs.
Preferred Stock ETFs
From the investor's viewpoint, preferred stocks are a blend of a bond and a stock. Their prices aren't volatile like common stock shares. The point is the dividends these shares pay. They also are considered safer than common stocks. Even in the event of bankruptcy, preferred shareholders are closer to the front of the line for repayment than common shareholders.
Preferred stock ETFs give the investor exposure to a range of preferred stocks, thus diversifying your portfolio.
Let’s start with a quick look at two of the most popular preferred stock ETFs.
Invesco Preferred ETF (PGX)
Tracks the ICE BofAML Core Plus Fixed Rate Preferred Securities Index. Financials as of Dec. 15, 2023.
- Total Assets: $4.51 billion
- 30-Day Average Volume: 5,653,676
- Expense Ratio: 0.50%
- 12-month Distribution Rate: 6.32%
- Inception Date: Jan. 31, 2008
- 3-Year Performance: -3.73%
iShares US Preferred Stock (PFF) ETF
Tracks the S&P U.S. Preferred Stock Index. Financials as of Dec. 15, 2023.
- Total Assets:$13.46 billion
- 30-Day Average Volume: 4,762,767
- Expense Ratio: 0.46%
- 12-month Trailing Yield: 6.87%
- Inception Date:March 26, 2007
- 3-Year Performance: -1.39%
The appreciation and high yield for the two preferred stock ETFs above might be tempting, but when interest rates increase they’re not likely to perform as well. Both also performed poorly during the financial crisis, demonstrating a lack of resiliency.
Bond ETFs
A bond is a loan to a corporation in return for a regular payment of interest. As with preferred stocks, the point of bonds, to the investor, is the regular income they generate.
All bonds are rated by one of several rating agencies for the creditworthiness of the companies that issue them. The highest-rated bonds may pay the least but are the safest. Low-rated bonds are riskier but pay better.
So-called "junk bonds" are at high risk of default by their issuers.
SPDR Bloomberg Barclays High Yield Bond ETF (JNK)
Tracks the Bloomberg High Yield Very Liquid Index. Financials as of Dec. 15, 2023.
- Total Assets: $8.6 billion
- Average Volume: 7,087,803
- Expense Ratio: 0.40%
- 12-month Yield: 6.60%
- Inception Date: Nov. 28, 2007
- 3-Year Performance: 0.95%
iShares 20+ Year Treasury Bond (TLT)
Tracks the Bloomberg Long U.S. Treasury Index. Financials as of Dec. 15, 2023.
- Total Assets: $51.33 billion
- 30-Day Average Volume: 49,313,246
- Expenses: 0.15%
- 12-month Trailing Yield:3.64%
- Inception Date:July 22, 2002
- 3-Year Performance: -15.12%
Still, these two choices illustrate the many situations in which yield or lack of it can be deceiving. Most investors chase high yield, not realizing that they’re often putting themselves more at risk for depreciation. A high yield doesn’t mean anything ifan ETF’s shares slide.
That’s the beauty of TLT. The yield might not be extraordinary (still relatively generous), and it tends to appreciate during difficult times because big money rushes to safety.
Note that JNK is not a symbol selected for a fund that invests in the highest-quality AAA-rated bonds.
The Bottom Line
Preferred stock ETFs are more appealing in low-interest rate times thanks to their high yields, but they’re not likely to appreciate as much as ETFs tracking common shares during bull markets.
Bond ETFs have a reputation for offering greater safety, but it depends on the bond ETF. For instance, JNK offers a high yield, but it’s not a place be during poor economic periods when defaults are more likely. TLT might not offer as much yield, but it offers resiliency and the low expense ratio is a bonus.
FAQs
Preferred stock ETFs can perform particularly well in comparison with bonds when interest rates are low. Bond ETFs can offer competitive long-term returns regardless of the movements of the stock markets. Both can offer steady income to the investor with very low costs.
Are preferred stock ETFs better than bond ETFs? ›
Bottom Line. Bond ETFs are generally best for conservative investors and those seeking income from their investments, while stock ETFs are best suited for long-term investors seeking growth over time. However, both types of ETFs can complement each other and combine to build a diversified portfolio.
What is the point of bond ETFs? ›
A bond ETF pays out the interest it receives on the bonds in its portfolio. So a bond ETF can be a good way to set up an income stream without having to worry about the maturity and redemption of individual bonds.
What are the cons of bond ETFs? ›
Interest rate risk: Like individual bonds, Bond ETFs are subject to interest rate risk. When interest rates rise, bond prices typically fall, and this can lead to capital losses for investors in bond ETFs. The degree of interest rate risk depends on the duration of the bonds held in the ETF's portfolio.
What is the difference between a bond and a preferred stock? ›
Key Takeaways. A bond is a fixed income instrument that represents a loan made by an investor to a borrower. Preference shares are shares of a company's stock with dividends that are paid out. Bonds often have a maturity date, while preference shares do not.
Why not buy preferred stock? ›
Since preferred stock comes with a fixed dividend yield, they are highly sensitive to interest rates. If market-wide interest rates rise above the yield of a preferred stock, it will become harder to sell that stock on the market, and investors would have to accept a steep discount if they wish to sell.
What is the best preferred stock ETF? ›
Here are the best Preferred Stock funds
- SPDR® ICE Preferred Securities ETF.
- Invesco Variable Rate Preferred ETF.
- Global X US Preferred ETF.
- Invesco Preferred ETF.
- AAM Low Duration Pref & Inc Secs ETF.
- iShares Preferred&Income Securities ETF.
- Global X SuperIncome™ Preferred ETF.
Prices will rally when interest rates drop and drop when interest rates increase. The higher the duration, the more ETF prices may move. Short-Term Bond ETFs and Money Market Funds have a very low duration.
Do bond ETFs pay monthly dividends? ›
Bond ETFs pay dividends on a monthly basis based on the interest income earned on the bonds held in the fund's portfolio.
What is the average return of a bond ETF? ›
Quarterly after-tax returns
| Total Bond Market ETF | 1-yr | 3-yr |
|---|
| Returns after taxes on distributions and sale of fund shares | 0.93% | -2.26% |
| Average Intermediate-Term Bond Fund | |
| Returns before taxes | 2.01% | -2.45% |
| Returns after taxes on distributions | — | — |
3 more rowsHere are the best High Yield Bond funds
- iShares BB Rated Corporate Bond ETF.
- Xtrackers Low Beta High Yield Bond ETF.
- Xtrackers Short Duration High Yld Bd ETF.
- JPMorgan BetaBuilders $ HY Corp Bnd ETF.
- iShares Broad USD High Yield Corp Bd ETF.
- Xtrackers USD High Yield Corp Bd ETF.
- SPDR® Portfolio High Yield Bond ETF.
Cons. Bonds are sensitive to interest rate changes. Bonds have an inverse relationship with the Fed's interest rate. When interest rates rise, bond prices fall.
Are bond ETFs taxed as capital gains? ›
Almost all bond ETFs are open-ended ETFs, though 17 are exchange-traded notes. Either way, you aren't taxed until you sell your shares. When you do, you owe capital gains tax on whatever profit you make. If you hold your shares for more than a year, you can use the lower long-term capital gains tax rate of 20 percent.
Why is preferred stock more risky than bonds? ›
The rating for preferreds is generally one or two tiers below that of the same company's bonds because preferred dividends do not carry the same guarantees as interest payments from bonds and they are junior to all creditors.
Who gets preferred stock? ›
Your VCs will get preferred stock; unlike your common stock, it will come with special privileges. Liquidation preferences reduce investor risk; understand what they'll mean in different scenarios. Don't come to the negotiating table without consulting with an experienced advisor first.
What are the disadvantages of preferred stock? ›
Among the downsides of preferred shares, unlike common stockholders, preferred stockholders typically have no voting rights. And although preferred stocks offer greater price stability – a bond-like feature – they don't have a claim on residual profits.
Is PFF ETF a good investment? ›
iShares Preferred and Income Securities ETF (PFF)
One of the most popular preferred stock ETFs with about $14.9 billion in assets under management, or AUM, is PFF. This ETF tracks the ICE Exchange-Listed Preferred & Hybrid Securities Index, which currently tracks 443 holdings and pays a 6.5% 30-day SEC yield.
What are the disadvantages of preferred shares? ›
Among the downsides of preferred shares, unlike common stockholders, preferred stockholders typically have no voting rights. And although preferred stocks offer greater price stability – a bond-like feature – they don't have a claim on residual profits.
Is it better to buy a bond ETF or individual bonds? ›
For many investors, investing in the right bond funds can be a better option than holding a portfolio of individual bonds. Bond ETFs can provide better diversification — often for a lower cost — can offer higher liquidity, and can be easier to implement.
Why do bond ETFs lose value? ›
Bond ETFs can lose value due to several factors, including changes in interest rates, credit risk, and market sentiment. When interest rates rise, the prices of existing bonds, which have lower interest rates compared to new bonds, tend to fall. Since a bond ETF holds many such bonds, its value can decrease as well.
