Rising share prices are driving down dividend yields. So where should investors like me look for passive income opportunities?
The FTSE 100 and S&P 500 are significantly higher than they were at the start of the year. As a result, dividend yields are down.
This means that investors looking for passive income have a few options. One is look for riskier stocks in order to find higher dividend yields.
I don’t like this approach, since I try to avoid risk when I’m investing. Prioritising a high dividend payment in the short term looks like a strategy that is likely to backfire over time.
Another option is to take lower returns by sticking to quality investments. I’d prefer this to the previous strategy over the long term, but I think there’s a better alternative.
The third choice is to look for investments outside of common stocks. This is where I see an interesting opportunity at the moment.
Preferred shares
With share prices high, I’m looking at preferred stock as a viable alternative. Warren Buffett has used these effectively throughout his investing career and I think they can be successful for me, too.
Unlike common equity, preferred shares pay a fixed dividend. That gives investors like me a better chance of knowing exactly what return they’re going to get on their investment.
Preferred shares also get priority regarding dividends. In other words, if a company’s earnings drop, dividends to preferred shareholders must be paid in full before common shareholders receive anything.
As a result, preferred shares are less uncertain than common shares. The downside to preferred equity is that holders of preferred shares don’t stand to benefit if the underlying business does well.
If a company makes more money year after year, common stock dividends are likely to go up. Dividends to preferred shareholders don’t do this — the cost of priority status is that there’s no growth.
A preferred stock can therefore be a good investment, since it’s likely to pay dividends consistently over time. But it needs to have a big enough dividend yield today.
Aviva
The stock on my list to buy is Aviva 8⅜% CUM IRRD PRF #1 — the preferred stock of Aviva. I think the return on offer today is an attractive passive income opportunity.
Aviva’s preferred shares pay a dividend of 8.375p per share. And the share price is currently £1.29, implying a dividend yield of 6.5%.
With the stock market where it is, I think a 6.5% dividend with the additional safety of a preferred stock is an attractive opportunity. That’s why I’ve been buying the stock for my portfolio.
There’s another bonus to Aviva’s preferred shares. They’re cumulative, so if the dividend is ever cut entirely, then missed preferred dividends have to be caught up before common stock dividends restart.
The biggest risk I can see with the stock is that they’re less liquid than common stocks. If the share price crashes, then I’ll find it more difficult to sell the shares.
I’m okay wih this, though. Since I’m looking for passive income, my ambition isn’t to sell the shares. It’s to keep them and continue receiving dividend payments indefinitely.
