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Vanguard - Fixed income - Preferred securities
Personal Investors

Preferred securities

Preferred securities combine the features of bonds and stocks. They represent ownership in a corporation like stocks (though generally with no voting rights) but provide periodic dividend payments like bonds. Most preferred securities are issued in $25 denominations.

Income

  • Dividends are usually paid quarterly and must be paid to owners of preferred securities before common stockholders. If the issuing company defaults, preferred security shareholders are paid after bondholders but before common stockholders.

Credit rating

  • Many preferred securities are rated by agencies such as Moody's Investors Service and Standard & Poor's Corporation. Ratings reflect the agencies’ assessment of the creditworthiness of the issuer and of the issuer’s ability to timely pay interest and repay principal in a timely fashion.
  • Moody's and S&P focus on an issuer's financial condition and credit history.
    • On the Moody’s rating scale, issues rated Baa3 or above are generally considered to be investment grade, while those rated lower than Baa3 are generally considered to be below investment grade.
    • On the S&P rating scale, issues rated BBB– or above are generally considered to be investment grade, while those rated lower than BBB– are generally considered to be below investment grade.
  • Preferred securities rated below investment grade are generally considered to carry a greater degree of risk than more highly rated preferred securities.

Disclosures

  • Issuers disclose information about preferred securities and details of their financial condition in a prospectus filed with the Securities and Exchange Commission. The prospectus, along with other continuing financial disclosures, can be found in the SEC's EDGAR database.

Types

  • Cumulative preferred securities are securities on which dividends, if deferred, will accrue and must be paid before the companies' common stock dividends. Accrued dividends must be paid before maturity or redemption. 
  • Non-cumulative preferred securities are securities on which dividends, if deferred, will not accrue and may never be paid. 
  • Trust-preferred securities are hybrids consisting of a preferred security issued by a trust set up by the issuer and funded by the debt securities of the issuer. The company issues a preferred security that pays dividends based on the interest the trust receives from the debt securities. The preferred security matures at the same time as the debt securities that the trust holds. 

Taxability

  • The dividends on some preferred securities may be taxed at a reduced rate.
  • Preferred securities may subject investors to capital gains taxes when sold or redeemed.
  • Some issuers can defer dividend payments without forcing the company into bankruptcy. If so, a tax liability may result for the investor on income allocated but not yet received.  Investors should consult a tax professional for additional information.

Liquidity

  • Vanguard Brokerage Services® does not make a market in preferred securities. If you wish to sell your preferred security, Vanguard Brokerage can provide access to a secondary market.  Liquidity will vary depending on a preferred security’s features, its rating or credit quality, lot size, and other market conditions. Preferred securities sold on the secondary market may be subject to substantial gain or loss.

Fees

  • On new preferred securities bought in the primary market, Vanguard Brokerage may receive a concession from the issuer. If a concession isn't available, Vanguard Brokerage reserves the right to charge a commission. Commissions will be charged for transactions in the secondary market.

Risks

  • Prices of preferred securities can rise or fall depending on interest rates. Interest rate changes have a greater effect on long-term and perpetual preferred securities.
  • All preferred securities carry the risk that the issuer will default or be unable to make timely payments of interest and principal. Highly rated preferred securities are presumed to have less credit risk than lower rated preferred securities. Credit risk can significantly impact preferred security holders since they are paid after bondholders. 
  • Some preferred securities have call provisions that allow the issuer to buy back the securities at a fixed price before the stated maturity date. Issuers typically call preferred securities when interest rates decline. Some preferred securities also have call provisions that allow the issuer to redeem the securities under certain conditions or special events.
  • Certain events can impact a preferred security issuer’s financial situation and ability to make timely payments to shareholders, including economic, political, legal, or regulatory changes and natural disasters. Event risk is unpredictable and can significantly impact preferred security holders since they are paid after bondholders. 
  • Preferred securities sold on the secondary market may incur a substantial gain or loss. The secondary market may also be limited.

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