Preferred vs Common Stock: Which is the Better Investment for You?

What Is Common Stock?

Common stock (also called ordinary shares) represents a basic unit of ownership in a corporation.

Holders of common stock typically have the right to vote on major corporate decisions, elect board members, and influence corporate governance.

As a component of shareholder equity, common shares form the backbone of most companies’ capital structures. These shares also reflect a company’s market capitalization, which equals the total market value of all outstanding common shares.

How Common Stock Generates Returns

Common shareholders earn returns in two main ways:

1. Capital appreciation: when the share price rises due to company growth or market optimism.

2. Dividends: periodic payments that depend on corporate profitability and dividend policy.

However, dividends on common stock are not guaranteed. In financial distress, companies may reduce or suspend them entirely. Moreover, common shareholders are last in line if a company liquidates its assets.

Despite the risks, common stockholders benefit the most when the company succeeds.

Over time, common stock tends to outperform other asset classes, rewarding investors who can tolerate market volatility and focus on long-term risk-adjusted returns.

Pros and Cons of Common Stocks

The below are the benefits and disadvantages of common stocks.

Pros of Common Stock

• Voting rights that shape company direction.

• Unlimited growth potential through capital gains.

• Eligible for stock buybacks and future dividend increases.

Cons of Common Stock

• High volatility during market downturns.

• Last in line for assets in liquidation.

• Dividends are not fixed and may be reduced or canceled.

What Is Preferred Stock?

Preferred stock is a class of ownership that sits between common equity and debt.

It is often described as a hybrid security because it offers fixed dividend payments (like bonds) while retaining an ownership stake (like common shares).

Preferred shareholders usually receive regular, predetermined dividends and have priority over common shareholders when those dividends are distributed. However, most preferred shares do not carry voting rights, limiting their influence on corporate governance.

Sub-Types of Preferred Stock

Companies issue different forms of preferred stock to meet specific financing goals:

• Cumulative preferred stock: unpaid dividends accumulate and must be paid before any common dividends.

• Non-cumulative preferred stock: missed dividends do not accrue.

• Convertible preferred stock: allows conversion into common shares at a preset ratio, offering growth potential.

• Callable preferred stock: can be repurchased by the issuer after a certain date, often when interest rates fall.

• Participating preferred stock: entitles holders to extra dividends if the company performs exceptionally well.

These subtypes affect how investors manage income stability and exposure to market changes.

Why Companies Issue Preferred Shares

Corporations issue preferred stock to raise funds without diluting voting control.

Preferreds help optimize financial leverage, provide predictable dividend payout ratios, and attract income-focused investors seeking steady returns with moderate risk.

Preferred stock thus functions as a financing tool for companies and an income vehicle for investors who value stability over growth.

Pros and Cons of Preferred Stocks

The below are the benefits and disadvantages of preferred stocks.

Pros of Preferred Stock

• Priority in dividend payments and liquidation.

• Stable income stream suitable for retirees and conservative investors.

• Less price volatility compared to common shares.

• Convertible and participating types add flexibility.

Cons of Preferred Stock

• Limited or no voting rights, reducing shareholder control.

• Interest rate sensitivity: prices fall when rates rise.

• Callable preferred stock may be redeemed when yields decline, limiting upside potential.

Preferred Stock vs Common Stock: Key Differences

The following table summarizes the major contrasts between the two equity types.

Ownership and Liquidation Preference

In a corporate liquidation, preferred shareholders are paid before common shareholders but after debt holders. This liquidation preference makes preferred stock less risky than common shares but still riskier than bonds.

Dividend Structure and Yield

Preferred stocks feature fixed dividends, resembling a bond coupon, while common stock dividends fluctuate with profits. The dividend yield on preferred shares is typically higher, appealing to those seeking reliable income.

Voting Rights and Corporate Governance

Common stockholders influence corporate governance through voting, mergers, and board elections. Preferred shareholders, lacking such rights, have limited say in company policy, trading control for income stability.

Risk and Return Trade-Off

Common shares carry higher volatility but also the potential for capital appreciation. Preferred stock is steadier but with capped upside. The choice depends on an investor’s risk tolerance and investment time horizon.

Portfolio Role and Diversification

Both securities can coexist within a diversified portfolio. Preferred shares provide steady income, offsetting the cyclical risks of common stocks, which drive long-term growth. Together, they balance risk and return for improved risk-adjusted performance.

How to Invest in Common Stock

Investing in common stock is one of the most popular ways to build long-term wealth through equity securities. Here’s a step-by-step guide to get started:

1. Open a Brokerage Account: Choose a reputable online brokerage. Look for platforms with low trading fees, access to international exchanges, and strong research and charting tools

2. Define Your Investment Goals: Decide whether your objective is capital appreciation, dividend income, or both. Your time horizon and risk tolerance determine how aggressively you should invest.

3. Research Companies Thoroughly: Before buying any stock, analyze the company’s:

   1. Market capitalization

   2. Financial statements (income statement, balance sheet, cash flow)

   3. Dividend policy and payout history

   4. Earnings growth and competitive position

4. Diversify Your Portfolio: Avoid putting all your capital in one company or industry. Diversify by:

   1. Holding 10–20 companies across sectors

   2. Including ETFs or index funds (like S&P 500 funds)

   3. Balancing risk through portfolio diversification

5. Reinvest Dividends: Use a Dividend Reinvestment Plan (DRIP) to automatically reinvest dividends into additional shares. This compounds returns and boosts your dividend yield over time.

6. Monitor and Rebalance Regularly: Keep an eye on company performance, earnings reports, and stock market volatility. Adjust holdings periodically to maintain your desired risk-adjusted return.

7. Stay Long-Term Focused: Common stock investing works best with patience. Short-term market swings are normal, but consistent investing over time captures growth and capital appreciation.

How to Invest in Preferred Stock

Preferred stock blends the stability of fixed-income investments with the ownership benefits of equity. It’s ideal for income-focused investors seeking steady dividends. Here’s how to invest in it effectively:

1. Choose a Broker That Offers Preferred Shares: Not all platforms display preferreds clearly. Look for brokers that list them under tickers ending in “PR” (e.g., “AAPL PR A”).

2. Understand the Type of Preferred Stock: Know what you’re buying before you invest. The main types include:

   1. Cumulative preferred stock: missed dividends must be paid later.

   2. Non-cumulative preferred stock: missed payments are forfeited.

   3. Convertible preferred stock: can be turned into common shares.

   4. Callable preferred stock: can be redeemed by the issuer.

   5. Participating preferred stock: offers extra dividends during strong profits.

3. Check Dividend Terms and Yield: Preferred stocks pay fixed dividends, so review:

   1. Annual dividend yield (percentage of par value)

   2. Payment schedule (quarterly, semiannual)

   3. Redemption or call provisions

   4. Compare options to match your income goals.

4. Evaluate Issuer Quality: Since preferreds rely on steady payouts, analyze the company’s:

   1. Credit rating (Moody’s, S&P)

   2. Profitability and debt ratios

   3. History of dividend consistency

5. Watch Interest Rate Sensitivity: Preferred prices move inversely with interest rates. When rates rise, preferred stock values often fall. Consider holding for the long term or during stable rate environments.

6. Diversify Using Preferred Stock ETFs: If you don’t want to pick individual issues, invest through:

   1. Preferred stock ETFs (e.g., iShares PFF, Invesco PGX)

   2. Closed-end funds (CEFs) that hold diversified preferred portfolios

7. Monitor Call Dates and Redemption Risk: Many preferreds are callable after five years. Issuers may redeem them early if interest rates drop, forcing reinvestment at lower yields. Always check the call date before investing.

Which Offers More Growth Potential: Common or Preferred Stock?

Common stock offers more growth potential because it participates fully in a company’s earnings and capital appreciation. As profits rise, common shareholders benefit through dividend increases and stock-price gains.

Preferred stock, with its fixed dividends and limited upside, focuses more on steady income than long-term growth.

Which Is Riskier: Common or Preferred Stock?

Common stock is generally riskier because its price fluctuates with market conditions and shareholders are last in line for assets if the company fails.

Preferred stock carries lower volatility and priority in dividends and liquidation, but it’s still sensitive to interest-rate changes. In short, common equals higher risk and higher reward; preferred equals lower risk and stable income.

Conclusion

The debate over preferred stock vs common stock is ultimately a question of risk, reward, and purpose. Both play vital roles in an equity investment strategy:

Common stock provides ownership influence and the potential for substantial long-term gains. Preferred stock offers reliable income, capital preservation, and priority treatment in dividends and liquidation.

A good investor often holds both types to achieve balanced and risk-adjusted returns.