There’s More Than One Way to Play: Take Risks or Play It Safe?
Common Stock vs. Preferred Stock
When you invest in a company you become a shareholder and are issued a certain number of shares. You become a stock holder!
There are different kinds of stock you can hold in a company.
Ever wonder what that little .PR or .PF means after a stock listing?Those two-letter tag-ons to a stock symbol mean that the stock is preferred. You can also own common stocks in a company. You’re still a shareholder, but common stock holders are at the bottom of the corporate food chain. Preferred shares of stock works a little differently than common shares of stock, and if you know how to use them, they can broaden your experience in the market and help you create a diversified portfolio.
In the post we will look at the difference between preferred and common stock and take a look at some of the pros and cons of each.
The Day-to-Day Details of Common Stock
When you buy a common stock you get a little piece of a company. Usually, you’re also buying a vote, a say in the company’s publicly influenced future. With common stocks, your fortunes are now tied to the fluctuations of the market. Common stock will ride the wave of the company’s success, the ups and downs of the corporation will manifest in the stock’s market value.One of the goals of owning common stock is earning capital gains. That is, you invest your money in hopes that the value of the stock will appreciate to the point that you can choose to unload it for a profit. Still, sometimes common stock will pay off before that, via dividends. When companies do well, they can elect to disburse some of their earnings back to shareholders — it’s a kind of reward for investing, from their coffers to yours.
The Trade-offs : How Preferred Stock Works
Preferred stock, however, works a little differently. For one thing, you probably won’t get a vote with your share. In exchange for voting rights, preferred stock guarantees you more access to financial advantages.
The trade-off works like this: If a company is going to pay a dividend, it’s going to pay its preferred stockholders first. Holders of preferred stock are at the front of the line for a disbursement. Second, while common stockholders never really know if a dividend is coming their way, preferred stockholders always know the ifs-and-whens of such payments. That information is typically provided up front, at the time the stock is bought. If for some reason a company doesn’t make its scheduled dividend payment, preferred stockholders are guaranteed the money before any further dividends are given out. Also, if a company should fold, preferred stocks qualify the shareholder for payment before common.
Creating the Right Mix
When choosing what kind of stock to own, it is important to consider that common stocks are riskier than preferred stocks. They stand to make you a little bit of steady cash, as opposed to common stock that offer grander payoffs that comes with the standard buy-low/sell-high brand of stocks.
In almost every case, robust or rocky markets are going to impact a common stock more acutely. Take a look at this chart.
It shows what happened to common and preferred stock offered by Citigroup since the Fall of 2008. As the economy tanked, the company’s preferred stock fell only a few percentage points in price, but Citigroup’s common stock plummeted some 80% in value. Now, that phenomenon can work both ways. If a company’s stock value soars, common stocks are going to ride that spike higher than preferred.
When you’re selecting which stock to buy, it’s worth keeping these “behavioral traits” in mind.
The Takeaway: What Common and Preferred Can Mean for You
One way to think about preferred and common stocks is to consider preferred stocks as something more like a fixed-income asset, like a bond. It will pay consistently over time, and you’re almost guaranteed not to lose money, but nobody buys a bond with dreams of getting rich in mind.
Preferred shares work well when you want to:
- Have some additional cash on a quarterly basis.
- Play the long-game: assuming a company will survive its ups and down and continue to supply a revenue stream over many years.
- Protect some of your portfolio from market unpredictability.
Common shares make sense when you’re looking for:
- A shot at higher returns on your initial investment.
- Play a shorter-game: watching fluctuations and making a move on an uptick even if you’ve only owned the shares for a few years.
- Takes some risks, have some fun, and hopefully cash in!
A mix of both preferred and common stock in your portfolio can help balance your exposure to risk, while providing you with both assured payback and also the potential to strike a lucky deal on the common-stock side of things.
To learn more about the different kinds of stocks you can purchase within a company, the rights the stocks give and how dividend payouts work check out the WSS course: Going Deeper with Stocks.