You know, when deciding to invest in stock, it’s crucial to understand the differences between preferred and common stocks. Let’s start with common stocks. Common stocks are what most people think about when they hear “stock market.” When you buy common stock, you essentially own a piece of the company. For instance, if you own 100 shares in Apple, you have a claim on a fraction of the company’s earnings and assets. The more shares you have, the larger your claim. And when it comes to returns, common stocks historically average a return of about 7-10% annually. That’s not bad, right?
On the flip side, preferred stocks offer a different kind of value. They are often considered a hybrid between a bond and a common stock. With preferred stocks, you get a fixed dividend, which is usually higher than common stock dividends. For example, if a preferred stock offers a 6% dividend yield, you know you’ll get 6% of the stock’s par value each year, regardless of how well the company performs. That’s a bit of security that common stocks don’t offer. In fact, during the financial crisis of 2008, many companies slashed their common stock dividends, but preferred stock dividends remained more stable.
Why would someone ever choose common stock then? Voting rights! When you own common stock, you usually have the right to vote on important company matters. Think of it like having a say in the company’s direction. For instance, during major decisions like mergers or electing board members, your vote can count. In one notable case, shareholders of Tesla had significant sway when Elon Musk proposed taking the company private at $420 a share creating a lot of buzz and media coverage. If you held preferred stock, you might have missed out on having a voice in that decision.
But preferred stocks aren’t without their own perks. Because they act somewhat like bonds, they are less volatile than common stocks. So if you're risk-averse, preferred stocks might appeal to you. For instance, during volatile market swings, preferred stocks tend to decline less in price compared to common stocks. It’s not a hard-and-fast rule, but generally, preferred stocks can make your portfolio steadier.
Let’s talk about liquidity. Common stocks are generally more liquid. Take Microsoft, for instance. With millions of shares traded daily, getting in and out of a position is usually a breeze. Preferred stocks, however, often have lower trading volumes. This could mean that buying or selling preferred stocks might take longer or could potentially affect the price more than it would with common stocks. Imagine trying to sell preferred stocks quickly in a volatile market; you might not get the price you want simply because there aren’t as many buyers or sellers.
Dividends play a big role too. Common stock dividends can increase if the company performs well. Let's say Coca-Cola had a great year. They might decide to reward their common stockholders with a dividend hike. Preferred stocks, however, usually pay fixed dividends, which won’t increase even if the company is doing extremely well. That steady income can be attractive, especially to retirees looking for consistent income without the roller-coaster ride of common stock price fluctuations.
Capital appreciation belongs to another story. Common stocks have higher potential for price appreciation. For instance, Amazon's common stock made early investors extremely wealthy as the stock price soared from $18 in 1997 to over $3,000 in 2020 before stock splits. Preferred stocks don’t typically offer that kind of growth. They are priced more like a bond and fluctuate in a narrower range. If you’re looking for massive growth potential, common stocks are where you'd aim your investment.
Lastly, in the unfortunate event of a company's bankruptcy, preferred stockholders get paid before common stockholders. This isn’t something any of us wants to think about, but it’s a safety net worth mentioning. During Lehman Brothers’ collapse in 2008, preferred stockholders were able to recover a portion of their investment whereas most common stockholders didn’t see much, if any, return. Understanding this hierarchy can help make a more informed decision especially in high-risk industries.
To sum up preferences, if you crave steady income and more security, preferred stocks might be your cup of tea. But if you're looking for growth and don’t mind some volatility, common stocks have historically provided better returns. And if you want to dive deeper into this topic, check out this Preferred vs Common Stock resource.
So, what’s your investing style? The decision ultimately boils down to your risk tolerance, investment goals, and need for income versus growth. Make sure you carefully consider these factors before making a decision.