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|What is preferred stock?|
|What exactly are zeros, and where do I buy them?|
|How should I build my portfolio?|
|Should I invest in individual stocks, mutual funds or ETFs?|
|Can I follow the Successful Investing Plan with the mutual funds I already own?|
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Jim Woods, Mark Skousen, Nicholas Vardy, Bryan Perry, Bob Carlson and Mike Turner are part of the Eagle Financial Publications group of financial investment analysts.
Preferred stock shares are issued by a company as debt instruments, much like corporate bonds. The company promises to repay the money lent by the investor and to pay interest (usually quarterly) to the preferred shareholder in the form of dividends.
The first group of stock a company issues is common stock; a company may then issue preferreds. Preferred-stock holders get “preferred” treatment over common-stock holders: Only after preferred-stock holders have received their dividends do common-stock holders receive any dividends. If a company should go bankrupt, preferred-stock holders will receive principal before common-stock holders, but after creditors and bondholders.
If interest rates fall, the issuing company must still pay out fixed preferred dividends. The prices of common stocks rise and fall with market conditions, but preferred-stock holders receive a fixed dividend year after year. Generally, this leads to greater price stability with preferreds than with common-share ownership.
Preferreds have similar characteristics to bonds, but there are several differences that will affect you and the issuing corporation. Bonds are simply IOUs issued with a promise to repay by a certain date. Both bonds and preferreds pay a specific dollar amount each year. From a tax standpoint, companies would rather issue bonds.
New issues are regularly offered with five-year call protection. That means the issuing company can’t pay off the loan (and must continue to pay you interest for at least five years). Brokers may try to convince you to sell a preferred at a profit rather than let it get called away from you at the call price. Most often, this advice is unable to stand up to mathematical testing.
Most preferreds are NYSE-listed and trade just like common stocks. You can open The Wall Street Journal any day of the week, turn to the NYSE stock listings, and find your preferred stock. Your issue has solid visibility.
So, here are the guts of how to play the preferred game. Let’s say you buy a new issue 7% preferred at the usual $25 with normal five-year call protection. Your preferred’s management cannot call your issue away from you for five years, and then only at $25 a share. And the entire time, you collect 7% per year, regardless of what the stock market does.
Treasury zero coupon bonds are a special kind of Treasury for growth-oriented investors. Like T-bills, notes, and bonds, they are loans you make to the government. However, they pay no interest while the loan is outstanding. Instead, the interest accrues, and you get paid all at once, along with the return of your principal, at maturity. But be aware that zeros are federally taxed as if they did pay current interest. You must pay taxes annually all along the way, just as if you had actually received the interest payment, even though you don’t. The term “zero” refers to the fact that you receive no current income. Zeros are for the investor who does not need current income.
Your profits are locked in with zeros if you hold them to maturity. But there is another way to use zeros in your portfolio to make even more money. Between the dates you buy and sell your zeros, the value of the zeros in your portfolio fluctuates directly with long-term bond rates. If rates go up, zeros go down. If rates go down, the value of zeros goes up. It’s just that basic.
Zeros are for investors looking to invest both long-term to meet specific goals and in a shorter course of the business cycle to reap more immediate gains. Zeros are not for income investors, novice investors, risk-averse investors or Nervous Nellies. If you are the least bit hesitant, if you are short-term-oriented or green, if you can’t sleep like a baby because of the volatility, please do not consider zeros–they are not for you.
STRIPS (Separate Trading of Registered Interest and Principal Securities) are a type of zero coupon instrument. When I talk about zeros in Intelligence Report, I am talking about government-issued STRIPS. When purchasing STRIPS, I recommend you deal with an active, seasoned broker at one of the primary dealers in STRIPS–like UBS PaineWebber or Merrill Lynch. You can really take a thrashing on brokers’ commissions with zeros. Do not buy from a discount broker because they buy from a primary dealer themselves and add another markup to you. You will pay a front-end sales charge of 3%–5% and more with brokers who are not both primary dealers and active, seasoned pros in the zeros market.
In most cycles, I recommend short and intermediate maturities. In the past, I have used long STRIPS in my program but am unlikely to again. The 1980s and 1990s were most likely a once-in-a-lifetime play for long bonds. Please check the most recent issue for my up-to-the-minute advice on our current strategy.
I advise you to maintain a constant balance in your portfolio between fixed-income securities, blue-chip stocks (and/or assorted mutual funds), and gold and foreign currencies. Your most important task is asset allocation. Portfolio balance and diversification tower above your securities selection as the foundation for your investment success. For most investors, I advise a 50-40-10 plan. You want 50% in fixed income, 40% in general equities, and 10% in gold and foreign currencies.
For the equities portion of your portfolio, I advise exactly 32 stocks (if you choose to invest in individual stocks), with no more than two from each industry. You will achieve approximately 90% of the diversification of owning all NYSE-listed stocks. Mutual funds are a great alternative as well. Invest equally in the stocks (or funds) you own, and once your portfolio is established, don’t buy a new stock unless you first sell a current position.
Once your portfolios are in place, do not mix and match fixed income holdings and equities. You want to maintain balance at all times. Why? Because I, like you, do not have tomorrow’s newspaper. We do not know the future.
To construct a brand-new 32-stock Retirement Compounders portfolio, proceed exactly as follows: (1) Buy the Top 10 from this month’s Intelligence Report. (2) Starting from last month’s issue, top down, add additional names not listed in this month’s IR. Then continue with the next most recent issue until your list totals a couple of dozen names. (3) Use the next couple upcoming issues to round out your list to 32 names.
For portfolios less than $350,000, absolutely go with mutual funds or ETFs – the commissions you’ll pay for individual stocks are a killer. Of course, even if you have the minimum or more, you may find mutual funds or ETFs to be easier and more rewarding.
Yes. Use the domestic plan buy and sell signals for domestic funds, the international plan for international funds, etc. If the funds you own have underperformed the funds we recommend and track, consider replacing them.
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