No. of Recommendations: 19
But if you reinvested the dividends from the preferreds, I think you would beat inflation.
Maybe.
Receive dividend, pay tax on it, purchase more of those preferreds probably well above par...
Assuming no change in market price of the paper, you lose the inflation rate on all your capital every year.
So you might beat inflation, but not by a whole lot.
A random example, WFC/PL is often mentioned here.
Currently trading at $1137, pays $75/year, indicated nominal yield 6.60%.
Let's say there is a steady rate of 5% inflation, the market price of the security remains unchanged, and you're paying 25% tax on the coupons.
Figures in today's dollars:
After a year your $1137 of capital is now worth $1080, and you have received $72.63 in coupons on which you paid $18.16 in tax for a net of $54.47.
Your total return after a year is -0.21%.
That's a negative real return.
If you use each coupon (assuming you pay tax as you go) to buy more shares, you can buy 0.0124 more shares each quarter.
After four quarters you own 1.0504 shares worth (today's dollars) about $1080, for a total value of $1134.43 in today's money. You're down $2.57 in total return.
Obviously the result depends on the yield of the security when purchased, its price trajectory, your tax rate, and the future inflation numbers. (and its default likelihood)
But one can generalize a bit:
Buying a high coupon security (which is usually picking a poorish security for solely that reason) just to reinvest the coupons is not generally very sensible.
Better to buy a better quality security without a coupon, or with a much lower coupon.
By extension, in general DRIPs are a pretty bad idea.
Jim
