Q: Are Canadian preferreds safe to hold for a decade or more for income?
A: Canadian preferred stocks are, generally, an excellent investment alternative for individual investors looking to maximize their after-tax income. Canadian dividends receive favourable tax treatment compared to interest income. There are, however, some caveats.
Firstly, we are reluctant to recommend any investment for 10 years or more. It is very difficult to forecast economic and interest rate trends with any degree of confidence over that period of time. Preferreds, because they carry a fixed level of payment, are particularly vulnerable to increases in interest rates. If interest rates were to increase at some point over the next 10 years- a likely occurrence- then the market value of the investment would decline even though the dividend payment remained the same. The market value of your investment would decline.
Secondly, while safer than common stock, preferred issues are more risky than bonds. This is because, In the event of financial stress, companies will first reduce or eliminate the common dividend. If that action does not alleviate the stress, then the preferred dividend may be reduced or eliminated. The interest owed on bonds is the last to be touched. Should the preferred dividend be reduced or eliminated, the value of the preferred stock will fall sharply. Before buying the preferred stock of a company it is important to analyze the issuer. Look for companies with predictable earnings streams and a consistent record of paying dividends.
Thirdly, preferred shares are generally much less liquid than common shares. This lack of liquidity, coupled with the fact that preferred issuers almost never increase the dividend, raises the potential of capital loss if you are forced to sell.
Fourthly, it is important to understand all the features of a particular preferred issue. For instance, some can be called away from you and at a price that might be less than you paid. Other issues may allow the company to change the amount of dividends you receive after a certain period of time. If you are dependent on the income you receive, understanding all the ramifications of these features is especially important.
Finally, diversification, as always, is important. Relying on the stability of just one or two issuers is risky. Often, depending on the amount of money or time you have available to manage your investments, pooled or mutual fund focused on dividends is a better alternative. These funds will be fully diversified and have managers able to minimize the risk associated with rising interest rates or financial stress.