But it also can be pretty confusing. Once you figure out what the stock market is and how it works, you still have to learn about the different types of assets out there. Youâ€™ll also want to do your research before you make any purchases.
Even if you feel fairly confident about investing in stocks, you may not realize that these basic securities actually come in two different flavors: common and preferred.
So what is preferred stock, and why would you consider investing in it? Read on to learn more about this unique asset category and the benefits that make it attractive to some investors.
In many ways, preferred stock and common stock are the same. In both cases, you purchase a small â€śshareâ€ť of ownership in the company, which has the potential to create profit based on the success of the enterprise.
But as the name suggests, preferred stock owners enjoy preferential treatment in some regards. Although they may not be eligible to vote on shareholder issues like those who own common stock, theyâ€™re paid fixed dividends on a regular basis â€” and theyâ€™re paid immediately after bonds but before common stock.
That means buying preferred stock puts you at a lower level of risk since your dividends outrank common shareholdersâ€™ if the company should fail or endure major losses. Of course, that pendulum swings in both directions: Since the dividends on preferred stocks donâ€™t fluctuate with the companyâ€™s market value, you may miss out on higher earnings if the company should see a sweeping success.
You can think about preferred stock as a kind of hybrid between common stock â€” which is the stock youâ€™re probably thinking about when you talk about the market â€” and fixed-interest securities like bonds. Preferred stock offers a way to invest in equity that provides some of the same security as other fixed-interest securities. However, preferred stocks generally offer higher growth potential than bonds do, and in many cases, they can be held indefinitely (as opposed to the predefined, shorter-term lifespans of most bonds).
|Â||Common Stock||Preferred Stock|
|Dividend Payout||Decided by board||Paid at regular intervals|
|Dividend Amount||Determined by profitability of company/market performance||Fixed dividend amount that may respond to changes in interest rate|
|Voting Privileges for Shareholders||Likely||Unlikely or reduced|
|Callability (Issuer Can Recall)||No||Yes|
|Riskiness||Moderate to high||Higher than bonds but lower than common stock|
|Growth Potential||High||Higher than bonds but potentially lower than common stock|
Like any other prospective investment, preferred stock comes with both benefits and drawbacks to consider before you add it to your portfolio.
As you can see, preferred stock inhabits a bit of a gray area. Itâ€™s usually not considered as safe as a bond and doesnâ€™t offer quite as much earning potential as common stock.
So when is it a good idea to choose this hybrid option?
However, itâ€™s important to keep in mind that preferred stock is a more advanced sort of investment than common stock or even bonds â€” which is why itâ€™s purchased less frequently than common stock, said Malik S. Lee, certified financial planner at Felton &Peel Wealth Management.
Although the differences weâ€™ve outlined above hold true generally, preferred stocks vary considerably in their individual features, which means itâ€™s extra important to do your research before you make an investment. For example, not all preferred stocks are callable, but some are;dividends might be cumulative (i.e. stackable if one is deferred) or noncumulative.
In short, â€śtheyâ€™re complicated,â€ť as Lee put it. â€śEach preferred stock will have different characteristics to it. Youâ€™ve really got to dive into the prospectus and look into what youâ€™re buying.â€ť
Ultimately, the only person who can decide if preferred stocks are right for your investment portfolio is you. (Although talking with a qualified financial advisor probably wouldnâ€™t hurt, either.)
If you do decide to invest in preferred stocks, youâ€™ll purchase them the same way you would common stocks or other securities: through a brokerage firm, which may levy certain trading and commissions costs at the time of purchase. To learn how to get started, check out our step-by-step guide to investing for beginners.