Is There a ‘Preferred’ Solution for Fiscal Cliff Investing?

While markets struggled this year, preferred stocks trumped nearly every investment class.

President Barack Obama acknowledges House Speaker John Boehner of Ohio while speaking to reporters in the Roosevelt Room of the White House in Washington, Friday, Nov. 16, 2012, as he hosted a meeting of the bipartisan, bicameral leadership of Congress to discuss the deficit and economy.
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Still, she says she considers them "a core holding in our non-bond income strategy" and lists them high among the "creative ways of finding income."

The emphasis on creativity is important, though, since it takes some research and investing savvy to sort through preferred shares offerings. It's complicated because preferred stock is a broad term given to a wide variety of interest-paying shares issued by companies. They include convertibles and trust shares, for example, that have much different tax advantages. Some guarantee cumulative payments, and some pay monthly. The devilish details can be tricky to decipher.

Regardless, investors have been stuffing cash into higher-paying preferred stock funds and individual shares at record levels as they move to one of the last good options for decent yield.

Preferred stock funds vs. individual stocks. By investing in funds, they spread out the risk of non-payment by a single issuer, which is two to three times as likely as it is with bonds since companies can opt not to pay dividends.

[See: The 10 Most Popular Mutual Funds of 2012.]

But the downside of investing in funds is that their payments tend to reflect the prevailing market rates, since they must continuously reinvest in the market to maintain liquidity. Cobb says he prefers to lock in yield as he can with individual shares. That is the one thing to consider in buying the securities, he says. "Capital appreciation is secondary. Preferred stock is all about income," he says.

With a fiscal cliff on the horizon, preferred stock is also about being nimble. Senate Majority Leader Harry Reid's warning on Thursday that Congress is not likely to have a deal before January 1 set off a new selloff. For investors, the new year is fraught with uncertainty.

"I would err on side of caution if I was deploying money today," he says. "I am putting in less today than I would be if this fiscal cliff was not looming. I am no fan of anybody in either party in Washington at this point."