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Why Preferred Stocks Don't Make Good Bond Substitutes

Their yields might look tempting, but they come with a few drawbacks.

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It’s easy to see the appeal of preferred stocks as a potential bond substitute. The 10-year Treasury yield is now hovering around 0.7%, and the Federal Reserve has indicated that it plans to keep benchmark yields low for the foreseeable future. At the same time, inflation has shown early signs of edging up. Fixed-income investors therefore face the unappetizing prospect of losing money in real terms over the next few years.

Not surprisingly, investors have been digging under a lot of rocks in search of income. As John Rekenthaler wrote recently, preferred stocks have been one of the most popular areas being discussed as a bond substitute. The eminent Burton Malkiel spoke favorably about preferred stocks on Morningstar's The Long View podcast in August. John has covered some of the pros and cons already; in this article, I’ll expand on some of the risks to be aware of.

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Amy C. Arnott does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.