At WiseGEEK, we're committed to delivering accurate, trustworthy information. Our expert-authored content is rigorously fact-checked and sourced from credible authorities. Discover how we uphold the highest standards in providing you with reliable knowledge.
A preferred ETF is an investment opportunity that allows the investor exposure to the preferred stock of multiple companies. The benefit of an ETF, or exchange-traded fund, is that it allows the investor a diverse portfolio but can be traded, giving the investor flexibility as well. With a preferred ETF, the investor gets preferred stock in several companies, which pays out dividends in regular installments and may, in some cases, be exchanged for common stock. In this way, the preferred fund combines the benefits of stocks and bonds.
Investors often must choose which way they enter the market and what type of exposure they prefer. If they choose stocks, they can gain significant returns on their investments and can trade liberally, but they must ride the ups and downs of the stock market along the way. Bonds are generally more stable, but the returns they provide are limited somewhat, and there is always the risk that the company issuing the bond might default. By investing in a preferred ETF, investors can get a little of both strategies in one investment.
Preferred stock is the most important component of a preferred ETF. When an investor receives preferred stock, he is entitled to dividend payments from the company issuing the stock. This makes the preferred stock somewhat similar to a bond, which pays out regular interest payments to the investor. If the company were to be liquidated or go bankrupt, the investor holding preferred stock would be paid after the debt holders but before those holding common stock.
Another primary benefit to the preferred ETF is that, in some cases, the preferred stock may be converted to common stock. This can be beneficial to investors because it gives them some flexibility. If the company's stock price is falling, an investor can keep the preferred stock and receive the regular dividend payments as a result. By contrast, if the stock price is going up, the investor may be able to make more of a profit by converting to the common stock instead.
Some investors looking to get the diversity available from mutual funds may look to invest in a preferred ETF as an alternative. An ETF gives them exposure to multiple top companies and corporations. With so many companies involved, it is less likely for the fund to be damaged by the poor performance of one or even a few companies. The ability to trade the ETF gives the investor more options than he might have with a traditional mutual fund.