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I need income and own preferred shares. Should I switch to bonds?

Dear Nancy Woods,

I have about six preferred securities which give me about 4-5 per cent return. As income is important to me, what is your opinion of this type of security? I recognize they are vulnerable to any increase in interest rates but at the moment they seem to be a better investment than any bond fund.

As I am 80 years old, the "long haul" is not that important. Income is.

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I would appreciate any thoughts you might have.

Thanks Dave

Dear Dave,

Preferred shares are typically classified in the investment industry as fixed income investments, although they actually are equities. They are both an equity and debt instrument, so they should be classified as a hybrid. They usually do not have a voting right, and pay a dividend. They have priority over common shares for the dividend payment, though interest payments for bonds get the highest attention.

Their price fluctuates because they are interest rate and credit quality sensitive. Unless it is a perpetual preferred there is an end date similar to a maturity date on a bond. Because the dividend payment amount is fixed, be aware that they do not benefit in the growth or profits of the company that issues them.

They do provide a similar source of income as a debenture, bond or stripped coupon. Because of this, we generally treat them as a fixed income investment.

The fact that their income is classified as dividend instead of interest is the appeal, especially when held in a non-registered account.

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As the preferred nears the call, retraction or reset date, the price gravitates back to the issue price, usually $25.

I think you need to be aware that unlike GICs that maintain their face value throughout their term, preferred shares, bonds and strip coupons fluctuate in market value. Their price is influenced by changes in the interest rates and credit quality relative to government issued debt of the same term.

If you are looking for income, with a lower taxation rate than interest bearing GICs or bonds, then the preferred shares you have are suitable.

Nancy

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Nancy Woods is an associate portfolio manager and investment adviser with RBC Dominion Securities Inc. To reserve a seat for her Feb. 27th seminar in Toronto, " Is Your Adviser Asking You the Right Questions?" visit her website www.nancywoods.com or send an email request to asknancy@rbc.com. You can send your questions to asknancy@rbc.com as well.

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About the Author

Nancy Woods, CIM, FCSI, is an associate portfolio manager and investment adviser with RBC Dominion Securities Inc. More

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