How to Evaluate a Preferred Stock Portfolio

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Higman
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How to Evaluate a Preferred Stock Portfolio

Post by Higman » Sun Apr 02, 2017 2:55 pm

My retired friend, 75 and single, is intrigued by the simplicity of a 3-Fund portfolio. He would like to try it but is not sure if it is better than what he has now. He is with Wells Fargo Advisors and showed me his last month's report and asked what I think. His overall portfolio objective is Moderate Growth and Income. He requires a fixed monthly withdrawal. It is all in an IRA. It returned 5.5% in 2016 (net of the 1% AUM fee). But his portfolio is a moving target. His current portfolio is somewhat different than 2016! His advisor did a big shift last month! Now his portfolio has about 50% in 12 individual dividend paying common stocks and 40% in 40 preferred stocks/fixed rate cap securities, and the rest in cash & misc. I can get a good handle on the common stocks, but can't analyze his preferred stock portion. I'm trying to figure out the portfolio's duration and credit risk. Overall yield on the preferred stock (on the report) is 6.17%. Many are callable and soon. Another problem is that his portfolio is a moving target from month to month. The Advisor buys and sells a few things each month. While the price of common stocks are fairly transparent the preferred bid/ask spread and markup is not. I have no idea if he is being charged a hidden markup on each stock. Some symbols are: AEH, BCS’A, CHSCM, C’K.
Is there any tool that can analyze each preferred stock or the entire portfolio? I’ve looked at M* Instant X-ray and Portfolio Visualizer but no luck. The only thing I have been able to do was to compare his 2016 total return (net 5.5%) to some comparable Vanguard options for 2016:

VTXVX Target Retirement 2015 6.16% (50/50 stock/bond) (VG risk Level 3)
VTWNX Target Retirement 2020 6.95% (60/40) (Risk level 3)
VSMGX Target Retirement Income 5.25% (30/70) (Risk level 2)
VSMGX Life Strategy Moderate Growth 7.13% (60/40) (risk level 3)
VASIX Life Strategy Income 4.58% (20/80) (Risk Level 2)
VSCGX Life Strategy Conservative Growth 5.96% (40/60) (Risk level 3)
VCVIX VG Convertible Securities Fund 6.62% (?/?) (Risk Level 4)
VMGDX Managed Payout 7.55% (?/?) (Risk Level 3)

It looks like he is doing OK as far as the portfolio is performing (5.5% net + 1% AUM fee). This makes it in the ball park of the above funds but I have no idea how much risk is involved. I’ve read Larry Swedroe’s book on Alternative Investments and he does not think much of preferred stocks. It would be so much simpler if he had just one of the above funds. And he would save the 1% AUM fee by switching his account to Vanguard.

Any suggestions?

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grabiner
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Re: How to Evaluate a Preferred Stock Portfolio

Post by grabiner » Sun Apr 02, 2017 5:44 pm

The problem is that you don't have a good benchmark. Preferred stocks, even if they pay out, behave like infinite-maturity bonds, so they lose a lot of value when interest rates rise. They also have an inflation risk which is not reflected in the actual returns; a preferred stock which pays a fixed dollar amount annually loses 5% of the value of that payment if inflation is 5%. Since interest rates have not risen much recently, preferred stocks have done well (until last fall); so have long-term bonds, which also have high yields.

If he needs a fixed monthly withdrawal, one way to get that guaranteed would be for him to put most of the money into an annuity (possibly inflation-adjusted) which covers that withdrawal. This would avoid the risk of the stock market falling and preferred stocks, or even bonds, not paying out; it would also avoid the risk of him outliving the money. If he is currently withdrawing more than 5% of the portfolio annually (including advisor fees), he probably needs an annuity. (The usual rule of thumb is that 4% is sustainable, but he is already 75, and thus doesn't need the portfolio to last forever. A portfolio which just tracked inflation would allow him to withdraw 5% this year, growing with inflation, and would last through age 95.)

If he has investments to spare, the natural option would be Vanguard LifeStrategy Conservative Growth. While it isn't guaranteed, he should be able to withdraw what he needs this year, increasing with inflation, and be unlikely to outlive the fund; he retains the option of buying an annuity later.

In addition, I would be concerned about the advisor changing the portfolio frequently; this increases both transaction costs and risk.
David Grabiner

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Higman
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Re: How to Evaluate a Preferred Stock Portfolio

Post by Higman » Mon Apr 03, 2017 8:10 am

Thanks David. I’ll try to explain the risk of preferred stocks to him and also run some annuity options (SPIA) taken at different ages for him. I appreciate your expertise.

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