Preferreds can be a great solution for increasing after-tax yield but they can be quite complicated. Getting good information can be difficult so some investors choose to invest in the preferred share index as an easy solution. I would think twice about using this ‘easy’ solution.
The S&P/TSX Preferred Share Index is designed to serve the investment community’s need for an investable benchmark representing the Canadian preferred stock market. This index is comprised of preferred stocks trading on the Toronto Stock Exchange that meet criteria relating to minimum size, liquidity, issuer rating, and exchange listing. This index is also rebalanced twice a year.
The S&P/TSX Preferred Share Index shows only capital gains and losses for the preferred shares and does not include dividends paid. For buyers of the index the dividends are paid directly to the investor. Right now the current dividend yield is 6.41% (March 31, 2010).
You can invest in the Canadian market simply by purchasing an exchange-traded fund (EFT) such as the Claymore fund (CPD). This seems like an easy solution to get some good income flow and exposure to the market.
I would think twice before making this decision for a couple of reasons.
The preferred share market isn’t without risks. Different types of preferred shares have different risk profiles with perpetuals being quite volatile. The index is comprised of about one third perpetuals. The index (on March 31 2010) consisted of 47.80% fixed/floaters, 31.83% straight/perpetuals and 20.37% convertibles. For low risk investors coming from GICs this volatility can be very surprising and difficult to take.
Many investors in their search for yield have been looking for more information on preferred shares. They see the great after tax returns that preferred shares offer and want to access to them.
The cost of buying the index isn’t free. The Claymore index fund has an MER of .45% in addition to the commission you must pay to buy and to sell each unit of the index. This is a low cost method of investing but it definitely isn’t free.
Investing in the index can be a great way to diversify your portfolio. But if you are looking for after tax income and managing your risk in your account I recommend buying individual preferred shares. This way you can customize the return you will receive and the amount of risk (volatility) you will take on.
The cost of this ETF is comparable to a full service fee-based account. A fee based account starts at 1.5% based on the assets managed and is reduced for larger account. Plus this fee is generally tax-deductible for non- registered accounts. With a fee-based account you do not pay commissions on trades.
Why not pay for good advice and prevent making any big mistakes. You will have a customized income portfolio that will be tailored to your individual risk profile and your income needs. It will pay off in the long run.
