There are certainly risks involved with investing in the financial sector of the market. While bank stocks have been on a tear lately, as represented by the Financial Select Sector SPDR's (NYSE: XLF) recent rise from its $5 low to its current $15 price, there are still some concerns in the segment. Nationalization fears have eased, but commercial real estate loan and credit card defaults are still in many analysts' minds. Add this to the decreased or non-existent dividend yields the group once possessed and the appeal of finance stocks diminishes. However, there is a way to play finance stocks with less risk and more distribution yield.

Digging Out Of Debt In 8 Steps

The Preferred Method
As a security that blends both debt and stock-like attributes, preferred stock is a great choice in the current uncertain environment for investing in finance stocks. The nature of these shares includes priority over common stockholders on earnings and assets in the event of liquidation and bankruptcy, second to bond holders. In addition, preferred shares have a fixed dividend, paid before common stockholders.

Cons for the share structure include the lack of voting rights and capped upside in the way of callability. The market for preferred shares is increasing in strength. Last year, dumping by hedge funds and other institutions brought yields on these shares to the 20 to 30% range.

However, the share class as a whole has returned to normal with yields averaging in the 8 to 10% range as investors have become more optimistic on the world economy. (For an overview on preferred shares, check out A Primer On Preferred Stocks.)

For retail investors it can be costly and difficult to purchase individual preferred shares. Many preferreds trade just a few thousand shares a day and can be research intensive as some financial institutions have several share classes each with their own dividend payment structures. Exchange traded funds offer individual retail investors the opportunity to allocate a portion of their portfolios towards preferreds.

The Big Three ETFs
All three of the major exchange traded funds in the sector are well off their respected 52-week lows, but still offer dividend yields in the 8% range and future price appreciation if the global economy begins to grow. With nearly $2.7 billion in assets, the iShares S&P U.S. Preferred Stock Index (NYSE: PFF) is the behemoth in the sector. The fund spreads its bets among a collection of 96 different preferred stocks with an 80% weighting towards financial stocks. The fund currently yields 8.50%.

From INVESCO's (NYSE: IVZ) successful PowerShares line of ETFs comes two preferred based funds, PowerShares Financial Preferred (AMEX: PGF) and the PowerShares Preferred Portfolio (AMEX: PGX). The PGX is more of general preferred fund similar to the iShares ETF. It spices its 86% weighting towards financial stocks with holdings in Xcel Energy's (NYSE: XEL) and Comcast's (Nasdaq: CMCSA) preferred issues as well as others. For its diversity, the PowerShares Preferred offers a slightly lower yield of 8.14% versus the PGF's yield of 8.9%.

The Bottom Line
While the economy seems to be improving, there are several big risks still ahead for the financial sector. In order to invest in the market segment, preferred shares make a compelling case. The relative safety of the share type and income opportunities available via investment in preferreds make it an ideal way for investors to get their feet wet in the banking sector. Exchange traded funds make it easy to add the security type to their portfolios.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Stock Analysis

    6 Hedge Funds With High Dividends

    Understand what value hedge funds can provide investors in the financial sector. Learn about seven hedge funds that pay consistent and high dividends.
  2. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  3. Chart Advisor

    Bumpy Roads Ahead In Transportation

    Investors are keeping an eye on the transportation industry. We'll take a look at the trend direction and how to trade it.
  4. Investing

    How ETFs May Save You Thousands

    Being vigilant about the amount you pay and what you get for is important, but adding ETFs into the investment mix fits well with a value-seeking nature.
  5. Mutual Funds & ETFs

    3 Fixed Income ETFs in the Mining Sector

    Learn about the top three metals and mining exchange-traded funds (ETFs), and explore analyses of their characteristics and how investors can benefit from these ETFs.
  6. Chart Advisor

    Agriculture Commodities Are In The Bear's Sights

    Agriculture stocks have experienced strong moves higher over recent weeks, but chart patterns on sugar, corn and wheat are suggesting the moves could be short lived.
  7. Investing News

    Top Tips for Diversifying with Mutual Funds

    Are mutual funds becoming obsolete? If they have something to offer, which funds should you consider for diversification?
  8. Professionals

    Top Stocks to Short, Go Long On to Beat the Market

    A long/short portfolio can help weather a variety of market scenarios. Here's how to put one together.
  9. Mutual Funds & ETFs

    Top 4 Asia-Pacific ETFs

    Learn about four of the best-performing exchange-traded funds, or ETFs, that offer investors exposure to the Asia-Pacific region.
  10. Mutual Funds & ETFs

    Top 3 Japanese Bond ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
  1. Who do hedge funds lend money to?

    Many traditional lenders and banks are failing to provide loans. In their absence, hedge funds have begun to fill the gap. ... Read Full Answer >>
  2. What licenses does a hedge fund manager need to have?

    A hedge fund manager does not necessarily need any specific license to operate a fund, but depending on the type of investments ... Read Full Answer >>
  3. What do hedge fund analysts do?

    A hedge fund analyst primarily provides support to a portfolio manager on how to best structure the hedge fund's investment ... Read Full Answer >>
  4. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  5. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  6. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!