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Investing 101

Preferred vs. Common Stocks

October 9, 2019

Want to invest in stocks, but don’t know which type to choose? Today, we’ll help you move further along your decision by explaining the difference between two different types of stocks, common and preferred:

Common Stock

What It Is

Most people talk about this kind when they mention stock investment. When you purchase common stock, you also get some benefits. Firstly, you own a part of the corporation whose stock it is. Secondly, you get voting rights. Usually, one vote per share is allotted. Thirdly, you will also be entitled to profits.

What It Brings

About the voting rights, buying common stock also provides you with a way in to the company’s corporate policy. You can elect board members who will be in charge of management’s major decisions.

Another benefit associated with common stock is its potential for long-term gains since it usually outperforms bonds.

What It Isn’t

Sure, when you invest in common stock, you keep getting dividends, provided the company does well. What its value was when you first bought it can also go up under such conditions. However, if the company does poorly, your stock’s value will also come down.

Another thing to keep in mind about common stocks is that the company’s board of directors reserve the right in deciding whether or not to pay out a dividend. In case of a missed dividend, it is usually because you got bumped back for a preferred stockholder.

Finally, if a company arrives in the position of insolvency, you – and the other common stockholders – will be paid last! The company must liquidate and pay its creditors and bondholders before they can pay you.

Preferred Stock

What It Is

Preferred stock comes in different flavors. Those include:

  • Participating preferred stock. If you hold that share, you are  entitled to increased dividends, provided common stock dividends are higher
  • Adjustable-rate preferred stock. As a shareholder, you will benefit if the Treasury bill and interest rates increase
  • Convertible preferred stock. As you’d guess, your stock can be converted to common type at a pre-decided rate
  • Straight or fixed-rate perpetual stock that doesn’t come with a maturity date but also has a set dividend rate

What It Brings

So far, you may prefer to invest in common. But wait, preferred stock has advantages too. For instance, it isn’t as volatile as common stock is.

Moreover, as a preferred shareholder, your claim over the company’s assets is greater. You can also expect the company to pay you a fixed amount regularly – usually higher than what the common stockholders get. Finally, you get paid first if the ship sinks!

What It Isn’t

Now let us discuss what the preferred stock isn’t. It may be less volatile or risky, but it also offers less potential for profit. You won’t have voting rights with this kind of stock. Finally, the company may call your preferred stocks at any time and for any reason. The callable nature of this stock can be problematic, but usually, shareholders are paid a favorable price when that happens.

Benefits and Drawbacks

A Matter of Dividends

Higher in the case of preferred stock, but this can change. That’s because the rate is already set when the stock is being issued. When the company is doing well, the dividends for common stocks may go up – and rise above those for preferred stock – while those on preferred stock will not.

The Right of Voting Rights

Common stockholders do get voting rights. However, in most cases, that doesn’t benefit them. For them to really be able to use those rights, holders of common stock must own a significant percentage of the company’s stock.

Key Differences

Here’s a quick look at the two types of stocks:

Common or Preferred – Which Is Better?

For investors who can take on slight risks to make up with a potential for higher returns, common stock is a better deal. However, for those of you who want minimal volatility in investment and potentially high returns of a stock investment, preferred stock is a better choice. Moreover, the latter type of stock is also better for people looking for a dependable source of income. You will also find that you don’t have to worry about the company’s profits affecting your dividends.

Regardless of which stock type you select, just ensure it is one that you’ll be comfortable holding for the long haul.

Purchasing Stock

After deciding the kind of stock you want to purchase, here’s how you can acquire some shares:

  1. Start by comparing the credit ratings of the specific kind of stock of different companies. Higher ratings indicate lower risk.
  2. Choose the right brokerage firm for yourself, based on trading support, ease of platform use, fees, commissions, and brand reputation.
  3. Follow the shortlisted stocks for at least one week. This will ensure you buy them at a low price.
  4. Decide how much you want to buy. We’d suggest being conservative when buying your first shares.
  5. Place an order with the brokerage of your choice.
  6. Monitor how well your stocks are doing.

 

Both investment vehicles differ from each other on the basis of risk tolerance, long-term returns, growth potential, and liquidity. Choose one that is suitable for you.

 

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