Preferred vs. Common Stock: What's the Difference?

The secondary market offers investors a way to trade existing securities, mainly equity and debt instruments. Among equity offerings, two primary share classes exist: common shares and preferred shares. Each serves different investor goals—capital growth vs. income stability. Understanding these distinctions of preferred vs. common stock is vital before selecting mutual funds that hold equities directly or through hybrid strategies.

• Table of contents

• Explaining the basics: Preferred vs. common stock
• What are common shares?
• What are preferred shares?
• Key differences between common and preferred stocks
• Evaluating the pros of preferred stock and their cons
• Assessing the pros of common stock and their cons

Explaining the basics: Preferred vs. common stock

Common stock represents ownership while carrying voting rights and a possible variable dividend, making shareholders residual claimants.

Preferred stock typically offers fixed dividends and priority over common stock in terms of dividends paid and liquidation, but typically has no voting rights.

Knowing the differences between common vs. preferred stocks can help new investors decide which class suits their objectives. Many mutual funds blend both classes, so understanding their traits aids informed fund choice.

What are common shares?

Common shares represent the fundamental ownership unit of a company, granting shareholders voting rights and a claim on residual profits. Dividends on common stock differ from preferred shares in that shareholder returns will fluctuate with the performance of the company, and are not guaranteed in times of poor performance. Common shares have four important attributes:

• Voting privileges on critical corporate matters.
• Variable payments to shareholders, available at the discretion of the board of directors.
• Participation in share price appreciation above the purchase price of the shares.

• Last priority in terms of claim against company assets in liquidation for debt and preferred claims.

What are preferred shares?

Preferred shares are hybrid securities with characteristics of both equity and fixed income. Preferred shareholders receive fixed dividend payments and have priority over common stockholders for dividends and asset claims, though they usually lack voting rights. Core features include:

• Fixed dividend rate, often tied to par value or benchmark rates.
• Priority claim on earnings and liquidation proceeds.
• Dividend payments that can be cumulative if missed.
• Callable features allowing issuers to redeem shares.

Also Read: Shares vs. stocks

Key differences between common and preferred stocks

While both represent ownership, they diverge in several ways:

• Voting rights: Common carries voting power; preferred typically does not.
• Dividend structure: Common dividends vary; preferred dividends are fixed and prioritised.
• Payment priority: Preferred shareholders paid before common in dividend distribution and liquidation.
• Price volatility: Common shares experience greater price swings; preferred stocks behave more like bonds.
• Growth potential: Common shares offer unlimited upside; preferred shares cap gains but ensure steady income.
• Convertibility: Some preferred can convert to common, adding flexibility for investors.

Evaluating the pros of preferred stock and their cons

Assessing the pros of common stock and their cons

Also Read: Shareholders Vs mutual fund investors

Conclusion

Ultimately, the choice between common and preferred stocks hinges on your goals and risk appetite. For steady income and lower risk, consider preferred stock in the income portion of your portfolio. If you're looking for capital gain and the ability to vote for directors, common stock would likely suit you better.

For mutual fund investors, this can be achieved by investing in a broadly diversified equity or hybrid fund which simplifies their allocation. Regular reviews of dividend income and tax-planning are mandatory and should include knowledge of differing tax treatments for dividends and capital gains. Enjoy the investment journey, and stay informed to make strategic investment decisions. Always consult your financial consultant when it comes to risk profiling and asset allocation. For mutual fund exposure, consider equity funds that invest in both share classes via a distributor under the regular plan.

FAQs:

What are the common stock vs. preferred stock advantages and disadvantages?

Common stock offers growth and allows for the right to vote but the downside is that dividends are not guaranteed. Preferred stock provides guaranteed income to investors but there is an upside limit.

Why are common shares better than preferred shares?

Common stock provides the right to vote. Also common stock has unlimited price appreciation.

Why might investors seek out preferred stock?

For guaranteed dividend income, additional stability, and limited downside risk with each share versus holding common stock.

Which offers more growth potential, common or preferred stock?

Common stock has the potential for more growth because of the capital appreciation via the share price.

Which is riskier, common or preferred stock?

Common stock has relatively better exposure to market volatility; preferred is more stable but interest-sensitive.