I'll use the
S&P/TSX PREFERRED SHARE INDEX (CAD) as my go to index of the entire Canadian preferred share market. It's useful because there is at least one ETF (iShares CPD) which tracks it.
Depending on your tax residence this analysis may apply to non-Canadian Preferred shares in non-Canadian portfolios but that would be coincindental.
Preferred shares (as defined above) in a Canadian portfolio have the following 2 big benefits:
1. They offer diversification because they're not the same asset class as stocks and bonds (sort of a hybrid). In Canada most preferreds
(about 75%) are of the rate-reset variety so the market value of an index of them would be expected to roughly go up and down with interest rates as opposed to bonds prices which generally move in the opposite direction of interest rates. In addition they have sginificantly safer dividends than common stock so there's an income factor there, although more variable and risky than bond income.
2. Distributions are taxed favourably due to the
Dividend tax credit. During the withdrawal stage of FIRE I think most Canadian individuals will be withdrawing between 20-40K a year of which maybe half or more could be coming out of their RRSP and taxable accounts. Preferred shares are eligible for the dividend tax credit which for people with low taxable income means they often get to keep all of the dividend. Early retiree preferred share investors could very well end up with a
negative marginal tax rate which they can apply to reduce taxes on other taxable income (like from your RRSP or savings account interest). I think this is one of the main reasons that preferred shares should get serious consideration from Canadians in the withdrawal stage of FIRE, especially if you've got some wiggle room for the variable nature of income coming out of a preferred shares index.
I also see some negative aspects as follows:
1. The main ETF that tracks the Canadian preferred market charges fee's of around .5% which is pretty high compared to an ETF charging around a tenth of that to track the Canadian common stock market.
2. Preferred share issues often have a call and/or expiry clause built into them allowing the issuer to get the preferred shares back based on certain terms and conditions (which are known in advance and therefore baked into prices according to the EMH). This means that characteristics of a portfolio of all preferred shares will change over time as shares are called back (or expire) and get re-issued under different terms.
3. There's no reason to expect the government to maintain the Canadian dividend tax credit. They could kill it or reduce it which would automatically cause a negative effect on the prices of preferred shares. The same argument could be made for cap gains, interest, rents etc. but it still is something to consider and a good reason for diversification in investment grade asset classes.
In a nutshell Canadian preferred shares (the total market) seem like a potentially good diversifier especially in the taxable portion of a Canadian portfolio for someone who has achieved FIRE.