Preferred Securities vs. Investment-Grade Corporate Bonds: Navigating Yield, Risk, and Tax Efficiency in 2025

In 2025, income-focused investors face a pivotal decision: Should they allocate capital to preferred securities or investment-grade corporate bonds? Both instruments offer attractive yields in a higher interest rate environment, but the trade-offs between yield, risk, and tax efficiency are more nuanced than ever. With the U.S. 10-year Treasury yield at 4.44% as of July 18, 2025, and corporate bonds offering average yields of 5.5%, while preferred securities trade at 6.5%, the yield spread between these two asset classes has narrowed to 100 basis points—half the historical average of 200 basis points seen from 2010 to 2019. This shift demands a closer look at how investors can optimize returns while managing risk.

Yield and Risk: A Tightening Spread

Preferred securities, which typically carry BBB/Baa credit ratings, have rebounded from their April 2025 lows and now offer a modest yield advantage over similarly rated corporate bonds. However, this narrow spread reflects a more balanced risk/reward profile. Preferreds rank lower in a company's capital structure, meaning they are paid after corporate bondholders in liquidation. This structural disadvantage is priced into their yields, but the current 100-basis-point gap suggests investors are receiving less compensation for the additional risk compared to historical norms.

For example, the ICE BofA Fixed Rate Preferred Securities Index currently yields 6.5%, while the Bloomberg U.S. Corporate “BBB” Bond Index yields 5.5%. This 1% difference is smaller than the 2% spread that historically justified the higher risk of preferreds. In a market where credit fundamentals are improving but economic growth remains sluggish, the margin of safety for preferred securities is tighter.

Tax Efficiency: The Hidden Edge of Preferreds

The tax treatment of preferred securities and corporate bonds remains a critical differentiator. Preferred dividends qualify for the lower long-term capital gains tax rates (0%, 15%, or 20%) for most investors, while corporate bond interest is taxed at ordinary income rates (up to 37% for high-income earners). For a single filer in the top tax bracket, this means a 17 percentage-point tax advantage for preferreds over corporate bonds.

Consider a $100,000 investment in each asset class. A corporate bond yielding 5.5% would generate $5,500 in taxable income, subject to a 37% tax rate, leaving $3,465 in after-tax income. A preferred security yielding 6.5% with a 20% tax rate on qualified dividends would yield $5,200 after tax—a 50% higher return. This tax efficiency makes preferreds particularly compelling for high-income investors in taxable accounts.

However, not all preferred securities pay qualified dividends. Investors must scrutinize the terms of individual issues, as some preferreds pay interest income taxed at ordinary rates. The 2025 “One Big Beautiful Bill Act” (OBBBA) preserves the tax-exempt municipal bond market but does not alter the preferential treatment of qualified dividends, ensuring the tax advantage for eligible preferreds remains intact.

Interest Rate Sensitivity: A Double-Edged Sword

Preferred securities often have long or no maturities, making them more sensitive to interest rate changes than corporate bonds. With the 10-year Treasury yield at 4.44%, and the Federal Reserve signaling potential rate cuts in late 2025, preferreds could face volatility if rates rise further due to inflation persistence or policy shifts. Conversely, a falling rate environment would benefit preferreds, as their yields are less likely to be eclipsed by new-issue debt.

Investors should also consider the equity market correlation of preferreds. While they behave more like bonds in normal conditions, they can exhibit equity-like volatility during periods of economic stress or market repricing. The recent tariff-related selloff in April 2025 demonstrated this, as preferred securities fell sharply alongside equities.

Market Conditions and Strategic Allocation

The current market environment—marked by a 2%–3% premium to fair value for equities and a projected 1.5% slower GDP growth in 2025—suggests a cautious approach. Preferred securities may offer a hedge against prolonged low-growth scenarios, but their risk profile requires careful due diligence. For conservative investors, BBB/Baa corporate bonds provide a lower-risk alternative with yields now competing more closely with preferreds.

Morningstar's equity analysts recommend overweighting small-cap and value stocks in 2025, which are undervalued and less correlated with interest rate-sensitive sectors. However, for income seekers, the choice between preferreds and corporates hinges on tax strategy and risk tolerance. High-income investors in taxable accounts should prioritize preferreds with qualified dividends, while those in lower brackets or with tax-advantaged accounts may find corporate bonds more appealing.

Conclusion: Balancing the Equation

Preferred securities still offer a compelling value proposition for income-focused investors, particularly those in higher tax brackets who can leverage their tax advantages. However, the narrowing yield spread and heightened interest rate sensitivity mean the risk premium is less pronounced than in the past. For conservative investors, investment-grade corporate bonds now present a more favorable risk-reward balance, especially in a market where credit spreads are tightening and economic uncertainty persists.

Ultimately, the optimal allocation depends on individual circumstances. Investors should prioritize tax efficiency, assess the credit quality of specific issues, and consider macroeconomic trends before committing capital. In a world where every basis point matters, the interplay between yield, risk, and tax efficiency will define the winners in 2025's fixed-income landscape.