Finance and Economic

In the past few weeks, Money 911 has looked at investments you can buy and manage on your own.

A portfolio of high-yield common shares – issued by banks, telecommunications firms, pipelines and utilities – can provide a double-digit average annual return over a period of five to 10 years.

That’s because your income comes from three sources: Dividend yield, dividend growth and capital gains when you sell the shares.

What if you find common shares too volatile?

Preferred shares are an option for risk-averse investors. They’re a halfway house between stocks and bonds.

"Preferred shares are called ‘preferred’ because their dividend must be paid before the common stock dividend (if any) is paid," says Keith Betty, author of an online investing guide, Shakespeare’s Investment Primer, www.shakesprimer.com.

Unfortunately, preferreds can be complicated. They come with a bewildering array of features that makes selection difficult.

Author Gordon Pape includes preferred shares in a portfolio for conservative investors. But he thinks they bear close scrutiny.

"They’re attractive because they are usually (but not always) stable in price, their distributions are reasonably predictable and they are eligible for the dividend tax credit, which makes them very effective in non-registered accounts," he says in his new book, Sleep-Easy Investing (Penguin, $26).

"The problem is that they come with all kinds of small print that sometimes catches even professional money managers by surprise."

A common irritant is a redemption clause, which allows the issuer to buy back the preferred shares at specific times for predetermined prices.

So, why invest in preferred shares? I asked James Hymas of Hymas Investment Management Inc. in Toronto, who runs a fund for high-net-worth investors, publishes a newsletter about preferred shares and has a website, www.prefblog.com.

"The common share investor is taking the first loss," he says. "Common shares provide a higher expected long-term return, but it could be a bumpier flight."

He points to U.S no fax payday advances. banks, hit hard by the credit crunch. News reports indicate that up to half of them may be cutting their dividends this year.

Preferred shares have a somewhat more secure dividend than common shares. Moreover, they trade in a tight price range, generally with no big gains or losses.

Suppose you have $10,000 or more to invest in preferred shares. Hymas recommends buying at least three issues with a top-quality credit rating, such as Pfd-1 from Dominion Bond Rating Service.

"If you can afford five to six issues, you can get a Pfd-2. And with 10 different issues, I wouldn’t mind too much if one was Pfd-3."

You don’t have much choice when it comes to sectors. A large proportion of preferred shares are from banks and insurance companies.

"With Canadian preferred shares, you have to resign yourself to a high exposure to financials," he says. "You can make allowances for that in the rest of your portfolio."

Smaller investors can buy a few preferred share funds that trade on the Toronto Stock Exchange.

The Diversified Preferred Share Trust is managed by Sentry Select and trades under the symbol DPS.UN. It has a year-to-date return of 1 per cent (after getting hit hard by the credit crunch last fall).

The Claymore S&P/TSX Preferred Share ETF trades under the symbol CPD. Its net asset value is down almost 4 per cent in the past year, but it has a current yield of 4.7 per cent, paid quarterly.

Money 911 takes a break next week and comes back on June 22, when we’ll look at how to reinvest your dividends for compound growth.

Ellen Roseman’s column appears Wednesday, Saturday and Sunday. You can reach her by writing Business c/o Toronto Star, 1 Yonge St., Toronto M5E 1E6; by phone at 416-945-8687; by fax at 416-865-3630; or at eroseman@thestar.ca by email.

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