Individuals looking to grow their wealth have many options nowadays. From stocks to foreign exchange to cryptocurrencies, there are countless ways to create a diversified investment portfolio. The stock market has always been a favorite of institutional and retail investors. If you’re planning to buy stock from a company, there are two options to consider: preferred stock and common stock.
Both types of stocks allow you to earn dividends and make you a partial owner of the company you have invested in. Common stock is the most prevalent type of stock that people invest in. Preferred stock, on the other hand, is considered a hybrid of a bond and common stock since it gives ownership to an investor (common stock) while providing fixed dividends (bonds). To find out whether you should invest in preferred shares, you should know the advantages and disadvantages of these hybrid stocks.
Overview: Preferred stock vs. Common Stock
The outline below summarizes the differences between common stocks and preferred stocks:
- Investors have voting rights
- Investors are paid dividends based on the company’s performance
- Investors are given dividends only after preferred stockholders get paid
- Investors do not have voting rights
- Investors enjoy fixed dividends
- Investors are a priority during profit distribution and asset liquidation
Preferred shares are considered low-risk compared to common stocks, but are riskier than bonds. Although common stocks have a better return on investment, profits will still depend on the company’s performance. Preferred stockholders enjoy guaranteed returns due to fixed dividends.
Preferred Stocks: How It Works
Preferred stock, also called preferred shares, is a hybrid of common stock and bonds. However, preferred stock shares more qualities with investment bonds, which are fixed-income investments. Companies pay out dividends, which are the profits of the company distributed to shareholders. Investors of preferred stocks receive fixed dividends regularly.
Most companies offer common stock and not preferred stock. In general, the market for preferred stock is quite small. Investors who are interested in acquiring preferred stocks can get them through banks, real estate investment trusts (REITs), and insurance companies.
What You Need to Know About Investing in Preferred Stocks
It is always recommended to arm yourself with the right knowledge and advice before participating in any investment. Fortunately, there are numerous sources of reliable investment advice, from books to online material. You can also take the best online courses to learn excellent investment strategies.
Before you start investing in preferred stocks, here’s what you need to know about them:
- Preferred Stock Investors Get Paid First
Investors holding preferred shares come first when it comes to dividend payments. Although dividends from preferred stocks are not as high as the dividends from common stocks, preferred stocks are suitable for investors who are looking for guaranteed returns.
- Preferred Stocks Are Less risky than Other Types of Stocks
If the company declares bankruptcy, the shares of preferred shareholders will be prioritized over common shareholders. Preferred stocks are less risky than different types of stocks, which makes it perfect for investors with a low tolerance for risks.
- Preferred Stocks Are Predictable
Unlike common stocks where the dividends depend on how the company performed, preferred stocks offer fixed dividends to its investors. If you’re an investor who wants to have a sense of the possible yields, preferred shares are the best option.
- Preferred Stocks Do Not Benefit from the Growth of the Company
Shareholders of preferred stocks do not get any tangible benefit from the growth of the company. Since the dividends from preferred stocks do not change, the increased profitability of the company will not affect the realized gains of preferred shares.
- Preferred Stocks Do Not Allow Voting Rights to Shareholders
Some investors stay away from preferred shares due to the lack of voting rights for shareholders. Preference shareholders cannot vote for or against company policy or voice out who they want to be part of the next board of directors. However, if you are an investor that prefers not to meddle with corporate affairs and only want to receive solid dividends, preferred stocks are a good idea.
- Preferred stocks are sensitive to interest rate fluctuations
Companies offer preferred stocks to raise capital without the need to obtain new debt. However, preferred shares are affected by fluctuating market interest rates, which can lower the value of preferred stocks. It works the other way around: if prevailing interest rates decrease, the price of preferred stocks will also rise.
Preferred stocks have certain privileges that investors will not enjoy with common shares. It is a suitable investment option for those who prefer fixed dividends and do not mind not having any voting rights for the company they’ve invested in.