Publicly traded companies can offer shares of preferred stock or common stock to investors to raise capital. Both can pay dividends, though there can be differences in how much is paid out and when those payouts occur. Between the two, more companies typically offer shares of common stock than they do preferred stock. Whether it makes sense to choose preferred stock or common stock can depend on your objectives for investing and whether you’re interested in having voting rights as a shareholder. Working with a professional financial advisor can be a great way to make sure you’ve fully considered all the factors that go into choosing which kind of stock to buy.
Preferred Stock, Definition
Preferred stock represents an ownership share in the company that’s issuing it. These shares can act like bonds, in that investors who buy in are usually offered a fixed dividend payout. Dividends are paid to investors on a set schedule for as long as they own preferred stock shares.
In that sense, preferred shares can offer some predictability to the investors who own them. When it’s time for dividends to be paid out, investors who own preferred stock are first in line, ahead of common stock shareholders.
Investors who purchase preferred stock shares don’t have voting rights. That means they’re excluded from any decision-making or voting that may take place during shareholder meetings. For example, if a new board of directors is being elected a preferred stock shareholder wouldn’t have a say in who is chosen.
Common Stock, Definition
Shares of common stock also represent an ownership stake in the underlying company. These shares can also pay out a dividend, though payment amounts and the timing for when they arrive is not fixed the way it is with preferred shares. Instead, common stock dividend payouts are set by the board of directors. The amount an investor receives can be tied to the company’s profitability for that particular dividend payout period.
With some companies, dividend payouts from common stock shares increase consistently over time. The Dividend Aristocrats, for example, represent the companies that have raised their dividend payout for 25 or more years consecutively.
It’s possible, however, that dividends associated with common stock shares could be reduced or eliminated altogether. If a company’s profits shrink because of changing economic conditions, regulatory updates or something else that could affect its ability to pay out a dividend to common stock shareholders.
If you own common stock, you’ll receive your dividend payouts after preferred stock shareholders have been paid. But common stock shares do offer voting rights to shareholders. So that means if you own common stock, you have the opportunity to vote on key decisions.
Preferred Stock Pros and Cons
Investing in preferred stock shares can yield several advantages. On the pro side, some of the best reasons to consider preferred stock include:
- Consistent dividend income, with fixed payout amounts and payment dates
- First priority to receive dividend payouts ahead of common stock shareholders or creditors
- Potential for larger dividends, compared to common stock shares
Aside from these benefits, some preferred stock shares may also be convertible. This means you can convert them to shares of common stock. That could make sense if you want to benefit from rising share prices. If you buy shares of preferred stock at one price and the common stock share price rises, you could convert some or all of your preferred shares to realize a capital gain.
On the other hand, preferred stock shares don’t offer voting rights. Whether that makes a difference to you or not can depend on how much you care about being able to help direct the company’s future. If you’re a hands-off investor by nature, then it may not matter as much.
Another potential downside has to do with liquidity. Common stock shares are more common, for lack of a better word. There are more of them floating around in the market, compared to preferred stock shares. If you want to sell your preferred shares, you may find it more difficult to liquidate them if you can’t find a ready buyer.
Common Stock Pros and Cons
Just like preferred stock, there are both advantages and disadvantages associated with investing in common stock. First, here’s what’s potentially attractive about investing in common stock shares:
- More accessible, as more companies issue shares of common stock vs. preferred stock
- Shareholders enjoy voting rights
- Common stocks can offer more potential for long-term price appreciation
Compared to preferred stock, common stock prices may offer lower dividend payouts. And those dividends may be less consistent, in terms of timing, based on market conditions and company profits.
On the other hand, investors who own common stock may benefit more over the long term if those shares increase in value. Investing in common stock may also be easier since you can purchase additional shares or invest in an index fund that allows you to hold a collection of common stocks.
One of the biggest drawbacks of common stock shares is that investors are paid last. So if a company goes bankrupt, for example, the preferred stock shareholders, creditors and anyone else the company has to pay would take precedence over common stock shareholders. That means it’s possible you could walk away with nothing if the company’s cash is depleted by the time your turn to be paid arrives.
Should You Buy Preferred Stock vs. Common Stock?
Whether it makes sense to invest in preferred stock or common stock comes down to what you need. If you want to have consistent dividend income over time, then preferred stock could be a better fit. The dividends may be higher than what you’d get with common stocks and depending on the stock, you may have the option to convert your shares. Common stocks may work better if you’re less interested in dividends than you are in long-term growth.
If you buy shares of common stock and that stock appreciates significantly over time, you could realize more of a benefit than you would from the dividends offered by preferred stocks.
Also, consider how important things like voting rights and payment priority are to you. If you want to be actively involved in shaping the company’s policy or choosing who sits on the board, then you’d most likely want to choose common stock. But remember that investing in common stock means you’d be paid last if the company goes under.
The Bottom Line
Between preferred stock vs. common stock, one isn’t necessarily better than the other. Both have advantages and disadvantages. Investing in a mix of each of one, not to mention other sorts of securities, could help with diversifying your portfolio to manage risk and rewards.
Tips for Investing
- Whether you choose to invest in preferred stock vs. common stock shares, it’s important to consider things like taxes and fees to preserve as much of your returns as possible. If you’re unable to purchase individual stock shares in a tax-advantaged account, such as a 401(k), you could do so through an online brokerage account. When comparing brokerage accounts, consider the fees you’ll pay to invest. While more brokerages are offering commission-free trades for U.S. stocks and exchange-traded funds (ETFs), some do charge fees so be sure to understand what you’ll pay upfront.
- Consider talking to a financial advisor about whether preferred stocks or common stocks make sense for your portfolio, based on your goals and risk tolerance. If you don’t have a financial advisor yet, SmartAsset’s financial advisor matching tool can help with finding one. You can get personalized recommendations for professional advisors in your local area. All it takes is answering a few brief questions to find your advisor match. If you’re ready, get started now.
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