Check out preferred stock when looking for yield

The rise in CD yields spurred by the Fed's rate hikes has disappointed fixed-income savers who like buying longer-term maturities. The biggest gains have been reaped by shorter maturities, ranging from about three months to one year -- hardly tempting enough to lock up your money for five years.

Some of these investors might be interested in preferred stocks, which may provide a way to earn 6 percent or 7 percent annually but, as you might expect, are riskier than CDs.

A preferred stock is sort of a cross between a stock and a bond. One reason for its appeal is its high yield, which is fixed just like a bond's yield. But the share price is not fixed and reacts to interest-rate moves, so there's no guarantee you'll get back your principal -- the price you paid for the shares -- also known as "par."

Preferred stock is often priced at $25 or $50 per share. As interest rates rise you'll see the share price fall and, conversely, when rates fall the share price will rise. But you probably won't see the significant price appreciation or depreciation that is often seen with common stock.

Dan Moisand, certified financial planner with Florida-based Spraker, Fitzgerald, Tamayo & Moisand, says misunderstandings can ensue if investors view preferreds as an alternative to bonds.

Substantial volatility
"If they view them as a form of stock they have less trouble. The volatility on the open market for preferreds can be quite substantial. If you have a good quality bond holding, and interest rates fluctuate, the market price will fluctuate. But you eventually get to the maturity date and the maturity value. With preferred stock, the price can drop precipitously in a rising interest rate environment."

Most qualified dividends are taxed at 15 percent (5 percent for people in the 10 percent or 15 percent tax brackets), but Moisand points out that with preferreds it's important not to be fooled into thinking that the dividend always will qualify for that low rate.

"Many preferreds are really prepackaged debt of the company that issues them and aren't true preferred stock. The interest can be entirely taxable as ordinary income instead of getting the 15 percent tax break," he says.

Preferreds can be found online and in newspaper stock tables, but until you're well-versed in the world of preferreds, rely on a broker or investment professional to help you select true preferreds that are right for your portfolio and your risk tolerance.

Ahead of those commoners
Another reason that preferreds are popular with some investors is preferred owners' principal, interest and dividends would be paid ahead of that of owners of common shares, in the event of a corporate bankruptcy. But preferreds aren't first in line; bond holders have priority.

Some preferreds are callable, meaning that the issuer can call back the stock at a specified time. This would be likely in a falling-rate environment. If you buy a preferred stock with a 6-percent annual yield and rates fall, the issuer is likely to call it at the first opportunity.

"If you buy and rates drop, you'll get dropped. If rates rise, you'll get stuck," says William Suplee, certified financial analyst and president of Structured Asset Management in Paoli, Pa.

"If you buy now at yields of 6 percent and rates continue to increase preferreds won't look good compared to 7-percent bonds because bonds have better creditor protection. When preferreds are really good investments and rates drop you tend to lose them."

If your stock is called, expect to receive par value for your shares. But if the stock isn't called and there's no default, your stock could continue paying the stated yield forever.