Preferred stock: a good way to diversify your investments that most people don’t think of. Preferred stock is an interesting topic for most investors. Most investors are pretty familiar with purchasing and owning stock. But when most investors think of stock, they probably think of common stock without even realizing it. Think of preferred stock as the cousin of common stock. They are in the same family, but have different characteristics and traits. Let’s dive into what it is, and how you might want to use it in your personal investing journey.
(1) Preferred Stock: Regular Dividends
Likely the largest reason for someone purchasing preferred stock is the benefit of regular dividends.
Dividends are basically the company giving the investor a regular income for owning the stock (preferred or common). Companies don’t have to pay dividends if they choose not to. Also, companies can increase or decrease the dividend as they desire.
Preferred shares of stock will nearly always pay a regular pre-determined dividend. The largest reason that investors purchase preferred stock is for the dividend income. Someone who wants to receive a regular dividend check (usually paid out quarterly) would probably want to invest in here.
However, it does not have the same potential for gain as common stock does. Think of it as the trade off. You are forfeiting the potential for massive gain in the stock price for the security of a regular dividend income.
(2) Preferred Stock: Priority Over Common Stock In Bankruptcy
No one wants to talk about the possibility of losing all of your invested money in a company, but sadly it is a possibility. It is probably a really small possibility, but a possibility nonetheless.
In the event of bankruptcy of a company, there are people waiting in a line to get paid all (or at least some) of their money that is owed to them. Most likely, not everyone will get paid so your place in line matters a great deal. If you own this investment, you will be ahead of regular (common) stockholders in that line. You may or may not get paid, but you are more likely to get paid in the event of bankruptcy.
Here is the order of parties that will be paid (simplified) from any remaining money in the event that a company goes bankrupt:
- Secured creditors (think of real estate loans, car loans, etc.)
- Employee wages
- Taxes
- Unsecured creditors (think of credit cards, lines of credit, etc.)
- Preferred stockholders
- Common stockholders
As you can see, it doesn’t move you ahead in the line very far, but simply moving in front of the common stockholders can greatly increase the chances of you getting at least some of your investment back if the company were to go bankrupt.
(3) Preferred Stock: No Voting Rights
One of the drawbacks of having this investment is that generally there are no voting rights associated with it.
When you own common stock, you have the opportunity to vote on things like new board members, structural changes to the business, new lines of business, etc.
When you own preferred stock, you have no such voting rights. If you want to vote on the goings on of the company, you need to purchase common stock and not preferred stock.
Final Thoughts
While there are certainly some other nuances and variations of preferred stock, these are the three main ones to consider when purchasing it.
If you are wanting a steady income in the form of dividends, this might be a good fit for you. You can also check out certain bonds, some blue-chip stocks, or REITs. All of those can also provide a steady dividend income.
Until next time!
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