Avoid Preferred Stock

Avoid Preferred Stock

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A major money center bank recently updated its website in such a way that before customers (and non customers) even log in they are encouraged to “Consider Preferred”.

Site users are immediately directed to a linked article that outlines the main benefits of bank-issued preferred stock (there are other companies that issued preferred, but the article focuses on bank-issued preferred).   The main benefit is that yields are higher than bonds issued by the same institution (the article partially attributes this to supply and demand imbalances from a refinancing cycle and partially attributes this to the fact that they sit lower in the capital structure) so that they now yield as high as 5% whereas the 10-Year Treasury yields 2.90%.   An additional benefit is tax treatment that is favored over that of bonds (preferred pay “qualified dividends”).

The article then goes into the risks.    One risk is that the preferreds sit lower in the capital structure than bonds and have a lesser stake in liquidation.   A second risk is that the dividend on a preferred stock is paid at the issuer’s discretion and can be turned off if the issuer first eliminates its common dividend.   (It is easy to discount these two risks as insignificant as banks are significantly more secure than in 2008).

Yet another risk is that call provisions could cause the yield-to-call to be significantly lower than the yield, which the article correctly cites as a serious risk for any instrument that is being purchased at a premium over its face value.

Finally, the article mentions interest rate risk.  It states: 

The perpetual nature of a preferred also brings interest rate risk, as there is no set maturity date in which the issuer must redeem the security. If longer term interest rates go higher, the price of the security may dip.

We think that this is the single biggest reason to avoid preferreds, and we don’t think that the risk can be well mitigated by buying fixed to floating rate preferred stock, as the article suggest.

Interest rates are going up.   We have stated that bond prices can get killed in a rising interest rate environment.   While BestCashCow is the most comprehensive source of CD rate information, we’ve also encouraged investors to consider carefully the implications of investing in long term CDs given the backdrop of short-term rates that are likely to move higher over the coming 12 months.

Preferred stocks, unlike bonds and long-term CDs, have no maturity date.  While these instruments can come under severe pressure in a rising rate environment, bond investors and CD investors always have the option of holding an instrument to maturity in order to receive their full principal (provided the issuer stays solvent).

As we move from an interest rate environment that has been lower than anyone alive has ever seen for longer than anyone imaged, it becomes entirely possible that we may never go back.   The Fed itself is guiding towards a Fed Funds rate of 3.375% at the end of 2020.   If short-term rates go there and stay there, long-term rates will presumably go higher, maybe much higher.    The value of instruments that represent a perpetual claim on an issuer’s assets without any date of redemption will fall, fall continuously, have no floor, and never recover.

It is very tempting to reach for yield here, but we think that prudence is especially warranted in a rising yield environment.   Savings rates are already pushing 2%, and, if you must reach, the premium offered by one-year CDs is higher than it has been in a decade.   See one-year CD rates here.


A Good Problem – Insuring Over $250,000 in a Single Bank Account

A Good Problem – Insuring Over $250,000 in a Single Bank Account

It’s nice to have over $250,000 in savings, but it is a pain in the neck to have to split the money up in more than one bank in order to ensure that it is all covered by FDIC insurance. 

Given the instability in America right now, full insurance on savings is a must.  FDIC is an independent agency of the United States government.  It protects depositors against loss of their funds were banks to fail.  The FDIC was created in 1934, during the Great Depression, and since its establishment no deposits insured by the FDIC have ever lost a single penny.

So full FDIC insurance makes all the sense in the world.  And, any savings or CD account today valued at $250,000 or less is fully insured.  Any account over that amount in insured only for $250,000.

There are, however, a number of ways to insure funds over $250,000 in a single account.  Some require rather obscure and complicated steps.  But two are easy and both make a whole lot of sense, especially because it is a lot less complicated when you have all your savings in a single bank.

One very simple way to keep your money in one bank and stay fully insured when you have over $250,000 is to open a joint account with your spouse.  In such a case, the full value of the joint account up to $500,000 will be insured by FDIC.

A second strategy, a bit more complicated than a joint account, is to open a Revocable Trust account.  Revocable Trusts are a smart way to organize your personal resources – far better than a will – and to enjoy FDIC insurance on a single account as high as $250,000 times each and every beneficiary.  Thus, if an individual names four beneficiaries, a single account can be insured fully for one million dollars (four times $250,000).

While Revocable Trusts may appear a bit intimidating, they are easy and relatively inexpensive to set up.


August 2018 Outlook: Savings Rates Increasing and Poised to Move Higher – 5 Accounts to Consider

August 2018 Outlook: Savings Rates Increasing and Poised to Move Higher – 5 Accounts to Consider

Rate information contained on this page may have changed. Please find latest savings rates.

We’ve entered the long hot days of summer with all sorts of political and economic turbulence on the horizon.

Savings rates have firmed and would seem to be poised to move still higher, with the Fed likely to raise the Fed funds rate by 50 basis points to 2.25% to 2.50% before December. 

CD rates too have firmed, and, as we recently noted in this article, the spread between 1-year CD rates and the online savings rates has widened out to 60 basis points which is the widest it has been in over a decade.   Some will be inclined to reach for CDs with money that they will not need for the next year (see today’s best rates here), but we’d be cautious, even with short term CDs against the current backdrop.

Longer term CD rates are quite interesting.   We now see online 2-year CD rates as high as 2.95%, 3-year rates over 3% and 5-year rates pushing 3.25%.   However, the Federal Reserve’s most recent forecasts continue to guide towards a 3.125% Fed funds rate at the end of 2019 and a 3.375% Fed funds rate at the end of 2020.  With the possibility of a protracted trade war and rising commodity prices causing real inflation, we think rates could be much higher and would be especially cautious here.

So here are five accounts we’d focus on:

Here are five products worth taking a look at:

1. Marcus – 1.85% Online Savings rate

Marcus has outstanding customer reviews and, with its lightening fast ACH transfers, it is a good place to stash cash that you might need to access quickly.  Marcus is also a subsidiary of Goldman Sachs and if you listen to their executives on Bloomberg or CNBC, you’ll see that they have made a real commitment to the online savings and CD spaces.   We doubt they will be doing anything other than raising rates as the Federal Reserve moves.  To boot, Marcus is perhaps the only one of the major online banks where it seems very safe to go well over FDIC-insurance limits.

Editor’s Note:  Marcus is an advertiser on BestCashCow.   Please read our Advertiser Disclosure here

2.  Ally Bank – 1.80% Online Savings rate

Ally has been around for many years and, as reviewed on BestCashCow, is the gold standard in online banks.   It isn’t a bank that is going to raise their rates one day only to lower them (or to stop raising them) the next.  As rates rise, consumers can have full confidence that Ally will always stay competitive.  We also know that they won’t be quietly lowering their savings rates while they give new customers better ones.   Their TV advertisements promise as much.

3. Radius Bank Online Savings – 1.86% (requires balance over $25,000)

Radius Bank is a new entrant to the online savings arena, but has a neat cutting edge user interface.  This savings account is also worth a look as it can be easily partnered with a high interest checking account packed with features that can enable depositors to migrate virtually all of their branch banking to online banking.

Editor’s Note:  Radius Bank is an advertiser on BestCashCow.   Please read our Advertiser Disclosure here.

4. Ally Bank 11-Month No Penalty CD – 2.00% (requires a balance over $25,000)

We’ve been a fan of Ally Bank’s No penalty 11-Month CD for years.   If you have over $25,000 to invest, it ordinarily offers depositors a light yield improvement over their savings rates.  Like a CD, this product, guarantees that it will pay the 2.00% amount for almost a year.   In the meantime, it can be terminated and moved to the money market account at any time and without penalty.  You are also protected from the extremely unlikely possibility of falling rates.   With this product, Ally is essentially offering depositors a free option.

  1. Colorado Federal Savings Bank One-Year CD – 2.51% 

If you must reach for a 1-year CD, Colorado Federal Savings Bank provides the highest yield in an account that can be easily opened and funded online.   Their website is not so great, and you will encounter some challenges if you have closed your funding account at maturity, but we think that this is one to look at.  Some others with rates almost as high are listed here. Again, only look at one-year CDs if you really feel you must reach for the yield and read our 65 Questions to Ask before locking into any CD.

Before opening an online savings or money market account, we also encourage you to check local bank rates and local credit union rates.