Easing into Bank Stocks

This may be the best news since learning chocolate and red wine are good for you: Financial stocks are making something of a comeback.

As with chocolate and red wine, of course, the key is choosing top-quality picks and enjoying them in moderation. Preferred shares, with their fat dividends and steadier share prices, are the most appealing, and owning several of them through an exchange-traded fund (which bundles stocks together so they trade as one) helps reduce the risk.

Preferred shares yield much more than common stocks and trade like bonds, with fewer big price swings (both down and up). And while companies in distress often cut their common-stock dividends, they usually leave their preferred dividends intact, providing an extra measure of security. That said, preferred shareholders can get wiped out if the company fails.

With so much uncertainty in the sector, investing in bank stocks is still a bit dicey. But the three preferred ETFs on the market — two from PowerShares and one from iShares — look deeply discounted. Each holds more than 80% of assets in financial stocks, which trade for 60 to 80 cents on the dollar, says Scott Burns, director of ETF analysis at Morningstar. As banks shore up their finances, preferred stocks could rally. In the meantime, preferreds pay dividends upwards of 10%.

The iShares S&P U.S. Preferred Stock fund (PFF) has 68 securities, including Wells Fargo (WFC) and Citigroup (C) and others like the mining firm Freeport-McMoRan Copper & Gold (FCX) and drug maker Schering-Plough (SGP). About half the portfolio is in “trust” preferred stocks, which are a little safer, says Mariela Jobson, an iShares portfolio manager. You may not see capital gains right away, but with its 10.6% yield, you’ll get paid to wait.