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Investing For Retirement: Preferred Shares Are Excellent


Investors preparing for retirement will need to assess their risk tolerance.

When investors look at measures like volatility, the daily volatility can be substantially misleading for preferred shares.

Investors should consider the call risk on issues trading at a premium to call value.

The quality of the company is critical to assessing the preferred shares, don’t bank on liquidation value.

I don’t care for technical analysis on common stock, but price history has some great uses when considering preferred shares.

When an investor wants to prepare their portfolio for retirement, they often start thinking about income more and growth less. The level of risk they can withstand in their portfolio is often materially lower than when they working. Investors may typically think of ability to bear risk as a factor that declines at a set rate over time, but that interpretation is far too simplistic. Prior to announcing their retirement, there may be materially more flexibility in deciding when an investor wants to stop working or how quickly they want to reduce their hours. If they encourage their employer to find a full time replacement, their ability to return to work and earn the same salary may be materially compromised.

Because the ability to earn income can be materially reduced, recovering from an unsuccessful investment can be substantially harder. This is one of the human factors that can play into a fairly sudden change in the ability to handle risk. Knowing that this point is coming for those with retirement on the horizon, I believe it is wise to start structuring the portfolio years in advance. For investors with a substantial amount of their assets in taxable accounts, that may often mean getting a personal financial advisor or another professional trained in tax law to assist with the planning stage. The importance of this step will vary depending on the individual investor's knowledge base, cash needs, and portfolio structure.

What Can Investors Do?

I would suggest that investors watch for quality offerings that go on sale. That is obviously much easier said than done, so the focus of this article will be on the process. We need to define potential investments and how those investments should be analyzed.

Measuring Volatility

Economic theory usually suggests that volatility and risk are synonyms. That makes sense in theory, but it breaks down in practice. The real challenge comes when an investor or analyst is tasked with defining volatility. Should we simply measure the change in dividend adjusted close for each day or each week? If the market were entirely efficient, a premise I strongly doubt, then the dividend adjusted close for each day would work. Since this theory expects everything to be perfectly efficient, then the risk could even be assessed by the minute.

The Problem with Measurements

When liquidity is strong, measuring volatility using closing values makes sense. When liquidity is weak, a better method is needed. For instance, investors measuring the volatility in preferred shares of a REIT may see the ending share price change by $.50 in a day. If the investment averages around $25, then we are talking about a change of about 2% in a day. This would lead investors to overestimate the volatility in some cases. If the average share price for each month lands between $24.50 and $26.50 for over a year, should investors really worry about a move of 2% that is still within the normal ranges?

While the examples above are given in a vacuum, rather than applied to the preferred shares of a single REIT, there are some easy examples. Preferred shares for Realty Income Corporation (NYSE:O) and National Retail Properties (NYSE:NNN) have had...