seeking advice

imark said:

I considered the following:
1- Canadian bonds : Yield for 3-5 years is about 3 percent. I understand that I can sell the bonds any time but I dont't know if selling price is fixed or subject to apreciation/depreciation?
2- investment in real estate to provide some regular rent income (minus costs) and hoping for property apreciation in the long run.

Is there better options? considering that I am 66 married to a wonderful wife who is ready to squander 5000 $ per month and who has free access to my credit card

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I would consider bank preferred shares. Here are a couple I own (bought them at much lower prices than currently during the crash):

CM.PR.G currently yielding 5.8%
BMO.PR.K currently yielding 5.5%
TD.PR.Q currently yielding 5.6%

Now unlike GICs, these products are uninsured so to be a little on the safer side, if I was investing a large sum of money I would spread it over the 5 big banks and possibly 6 if you include the National bank. In order for an investor to lose their money, these banks would have to go bankrupt and even then preferred shareholders rank higher than common share holders, so they may still recoup some of their principal. It's not an impossible risk, but an extremely unlikely one and one that I would be willing to take. (I think if all the banks went bankrupt, we'd all be screwed regardless of whether or not we held their preferred shares.) You could also always go half GIC/ half preferred if you wanted a little more safety. Preferreds can be sold at any time at the market price, which can sometimes fluctuate quite drastically (but generally preferreds are much more stable than common stock).

These products tend to be fairly thinly traded, so if you are interested in this sort of product and are not familiar with investing it may be worthwhile to use an adviser or ask the advice of a friend who is knowledgeable of investing.

Disagree strongly with presenting Preferred Shares as 'safe'. The only ones that would come anywhere close to that description are the very few ones with onerous reset provisions that guarantee an exit point. The OP does not have the training to find and evaluate those.

Not only do Prefs have most all the corporate risk as common shares, they can also change in value A LOT. Start reading at this page in order to learn all the things you have to know BEFORE buying Prefs.

Regarding Government debt: Brokers will charge you about 1.5% for every debt transaction. When interest rates are so low, subtracting 3% from your cumulative return probably wipes out its attraction. So thinking you will be selling it before it matures is a bad idea. Only buy those you will hold to maturity. At maturity you can be assured of receiving the Face Value.

People usually buy preferreds as a fixed-income type product within a taxable account. They would be more appropriate for those seeking income rather than capital gains. There is an extra margin of safety over common and more importantly the dividends are usually more secure. That may be relatively unimportant to many of you, but it can be vitally important for a retiree depending on them for income. That's why I thought they may be a consideration for the OP and also a product that I am considering for part of the portfolio of my mother if she sells her house.

As for myself -- I bought a few because the price was irresistible during the crash. But I have recently been selling them off for some of the reasons mentioned. However, I still feel that Canadian bank preferreds are a product that should be considered by someone seeking relatively safe (not perfectly safe, I know) income for 15 years as the OP was. I wouldn't say the same about common stock in that particular case.

"People usually buy preferreds as a fixed-income type product within a taxable account. They would be more appropriate for those seeking income rather than capital gains. There is an extra margin of safety over common and more importantly the dividends are usually more secure."

and what I am saying is that is a mistake. Bonds get a heck of lot more preferrential treatment then preferreds, when everything hits the fan and that margin of safety you speak of over common ... well not many preferred shareholders have ever received anything in a bankruptcy and in most of those cases, the preferred dividends were lucky if they were paid for even 4 quarters after the common share dividends were cut. Tax benefits do not compensate enough for this.

Preferreds do not pay a reward commensurate with the risk. The only exception is distressed preferreds that eventually trade like common shares. However, since most people buy them from well stable companies, they will simply deplete your wealth over time, on average.

"AFAIK there has never been a reduction in dividends or loss of principal with Canadian bank preferreds."

AFAIK there has never been a reduction in dividends or loss of principal with our current Canadian bank's common shares as well (unless you sold them for less than you bought them, then that's your fault).

I will point your attention to Royal Trust preferreds in 1992 (Canada's sixth largest bank/trust company, at the time). Those investors lost everything. Now the common shareholders lost everything, as well, but my point is the huge difference in the upside of the two. If your upside is limited, like it is with bonds and preferreds, then do yourself a favour and buy the bonds. IMO, preferred shares are for people who cannot calculate risk and reward properly. I am not saying you can't make money from them, I am just saying it is not worth the risk.

OptsyEagle said:

If your upside is limited, like it is with bonds and preferreds, then do yourself a favour and buy the bonds. IMO, preferred shares are for people who cannot calculate risk and reward properly. I am not saying you can't make money from them, I am just saying it is not worth the risk.

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Would you say that you have trouble calculating risk and reward properly?

I ask this because the actual historical returns from investing in preferred shares lead to a different conclusion. My own portfolio of preferred shares has returned over 31% on average for the last 12 months period -- very similar to the returns generated by the TSX and with measurably less risk. Those are just amateur returns; the Malachite Aggressive Preferred Fund gained double that in 2009 and has a stellar long term return (8 years) in excess of 13%/annum. You like to focus on the Royal Trust debacle and the complete loss to preferred shareholders in that situation when there have been other instances since that time where the seniority of preferred shares has served the holder well; TRP, BBD and most recently MFC come to mind along with a whole host of US preferreds in the financial sector.

Dealing in generalizations does no one any good especially when they are liberally sprinkled with misconceptions and personal bias.

scomac, I am glad your luck has continued with your preferreds. It will end, however. Now that the speculative element has past, your preferreds will trade like bonds, but unfortuneately they are not.

Using the example of a 6% preferred return, you only need 1 in 16 to turn out badly to wipe out your return, while none of them will have enough of a positive result to prevent this.

With common shares a 1 in 16 bad experience would put your portfolio performance in the top 1% of all portfolios.

With bonds, since you would most likely get 10 cents, 20 cents or even 50 cents on the dollar when things turn out badly, (as compared to 0 cents for preferreds) you could easily support 4 or 5 out of 16 mistakes and still have a good return.

Unfortuneatly here is no way to calculate this, it is just a concept that should be easy to embrace. Remember, all the preferreds that left the investors crying, do not exist anymore. That is the problem I am talking about. To particapate in that, for a lousy 6% return is foolhardy. IMHO.

Good luck to all who try.

OptsyEagle said:

• Using the example of a 6% preferred return, you only need 1 in 16 to turn out badly to wipe out your return, while none of them will have enough of a positive result to prevent this.

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What you are saying is that 1 in every 16 preferred shares issued must default each and every year in order to wipe out all investment returns from a portfolio of preferred shares over the lifetime of this investment. What is the probability of that happening? Have you ever bothered to try and figure this out based on actual data?

A quick Google search turned up a research document from the Rotman School of Business entitled Bond Prices, Default Probabilities and Risk Premiums1. We can use this as a guide to help determine the annual default rate of investment grade preferred shares as preferred share ratings correspond to bond ratings fairly well. From the chart provided in the document, you will see that one would have to get down to a Ba or B rated bond before you got to the rates of default that you are assuming in your example. Those particular bond ratings correspond with a Pfd-4 or a Pfd-5 based on this DBRS ratings scale. The real world incidence of investment grade corporate bond defaults is less than .5% on an annual basis, so it is reasonable to conclude that similarly rated preferred shares will have a similar incidence. Even if the incidence of preferred default is twice as high as comparable corporate bonds due to subordination, it is still far, far below the default rates that you are using above. Preferred shares with implied default rates as high as you speak will be trading at hugely distressed prices that will give equity-like returns far in excess of 6%.

OptsyEagle said:

• Remember, all the preferreds that left the investors crying, do not exist anymore. That is the problem I am talking about. To participate in that, for a lousy 6% return is foolhardy.

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I get the distinct impression that you have had a bad experience with preferred share investment in the past. Perhaps it is the Royal Trust fiasco that you have spoken on several times. That’s about all I can conclude based on your apparent certainty that they are a terrible investment and I will ultimately be screwed. One might legitimately ask you that if risking a complete loss of capital for a lousy 6% return is foolhardy, then why do you invest in equities at all because you have absolutely no assurance that your returns from common shares will be any better over the long run.