Stock Trade-Off:
Common or Preferred?
When people talk about stocks, they are most often referring to the class
known as common stock. It's well known that common stocks have the potential
for capital appreciation, and they have produced a higher historical return
than most forms of investment, but this has come with the increased risk of
losses and more volatility overall.
Fewer people are familiar with the attributes of preferred
stock. Preferred stock has been described as a security with a
"fixed income' personality, or an instrument that is somewhere between a
common stock and a bond. Here's what every investor should know about the
less-famous member of the stock family.
Like common stock, preferred stock represents ownership in a company.
However, that is where the similarities end. Owners of common stock receive
one vote per share when electing the board members who oversee decisions
made by management. Owners of preferred stock generally have no voting
rights.
Most preferred stocks pay a fixed dividend for as long as you own the
stock, whereas common stock dividends vary and are determined by the board
of directors. In both cases, dividends can be suspended, but preferred
stockholders are entitled to their dividend payments before common
stockholders. In the event that a company is liquidated, creditors and
bondholders are paid first, then preferred stockholders. Owners of common
stock are paid last.
The market prices of preferred stocks typically do not fluctuate as much
as common stock prices, but like bond prices, they are sensitive to changes
in interest rates. As rates go up, prices go down — and vice versa. Another
bond-like attribute: Many preferred stocks have call features that allow
companies to buy them back.
The return and principal value of stocks fluctuate with changes in market
conditions. Shares, when sold, may be worth more or less than their original
cost.
Investors who are seeking a steady income stream may appreciate the
higher dividend payments associated with some preferred stocks. An
examination of your situation can help determine whether specific common or
preferred stocks are appropriate for your portfolio.
