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What are Preferred Stock Mutual Funds?

By K. Kinsella
Updated May 16, 2024
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Preferred stock mutual funds are investment vehicles that exclusively contain preferred stocks issued by corporations. These funds are attractive to people who seek to make income from their investments, as the preferred stock mutual funds pay regular dividends. Most preferred stock mutual funds are closed-end funds with limited numbers of shares that contain stocks from companies in one particular sector of the economy.

Corporations issue two types of stock: common stock and preferred stock. Both stocks represent an ownership stake in the company, but common stockholders have voting rights, whereas preferred stock holders have none. Preferred stocks pay a fixed dividend that usually exceeds the variable dividends paid to common stock holders. When companies file for bankruptcy, preferred stock holders can make claims on the company's assets before common stockholders, and the latter only receive any money if all of the preferred stockholders claims have already been satisfied. Solvent firms do not pay any dividends to common stockholders until all of the preferred stock holders have received their dividends.

Most mutual funds contain a variety of stocks, bonds, and other commodities. Consequently, regular mutual funds are not best suited to containing just preferred stocks. Closed-end preferred stock mutual funds contain a set number of stocks, and investors can buy shares in the fund during the initial public offering (IPO). After the IPO investors cannot buy shares of the fund directly, but existing shareholders can sell shares on the secondary investment market. Shares trade like stocks, and the prices fluctuate based on supply and demand rather than the value of the underlying stocks.

Preferred stocks often pay high dividends, and are an attractive alternative to corporate bonds. Bonds represent a more conservative investment because in a corporate bankruptcy, bondholders must be paid ahead of preferred stock holders. The greater earnings on the stocks are indicative of the greater risks that stock holders must endure. Preferred stock mutual funds are less risky than individual stocks because if any one company goes bankrupt, only that stock will lose value as opposed to the entire fund.

Shares of preferred stock mutual funds sometimes prove to be more illiquid than shares of other mutual funds if the shareholders cannot find buyers willing to match the ask price. People with shares in regular mutual funds can redeem the shares by selling them back to the mutual fund company. Preferred stock mutual funds are also more volatile than other mutual funds, since the funds typically only contain stocks from one sector of the economy. When a certain sector does well share prices rise, but the opposite occurs when a sector performs poorly.

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