Common Stock vs Preferred Stock: Which one to choose based on your investment profile?

When you decide to invest in stocks, you need to understand that not all are the same. Public companies issue different types of shares, each with distinct rights and risks. Choosing between a common stock and a preferred stock can define your profitability strategy. Here we break down what distinguishes these two categories and how they impact your portfolio.

Two Investment Universes: Common vs Preferred

There are mainly two categories in the market. Common shares are the most accessible and popular, while preferred shares represent a more conservative option. Both confer ownership in the company, but their fundamental characteristics differ significantly.

Common Shares:

• Provide voting rights at meetings
• Variable dividends based on company profitability
• Greater potential for capital growth
• In case of liquidation, paid after creditors and preferred shareholders
• Higher price volatility

Preferred Shares:

• No voting rights in corporate decisions
• Fixed and more stable dividends
• Priority in profit distribution
• In bankruptcy, paid before common shares
• Sensitive to interest rate changes

The choice depends on your time horizon and risk tolerance. Aggressive investors seek common shares; conservative investors prefer preferred shares.

What Characterizes Preferred Shares?

Preferred shares occupy a hybrid space between debt and equity. They are classified accounting-wise as equity, but their behavior resembles more fixed-income instruments. Dividends are usually fixed or have a pre-established rate, although the company is not legally obliged to return the invested capital as in a traditional bond.

Variants of Preferred Shares

Within this category, specialized modalities exist:

• Cumulative: unpaid dividends accumulate for future periods
• Non-cumulative: no right to overdue dividends
• Convertible: can be transformed into common shares under specific conditions
• Redeemable: the company can buy them back
• Participating: dividends linked to actual financial results

Financial Rights and Priorities

In the liquidation hierarchy, preferred shareholders rank above common shareholders but below creditors. Although they are classified as capital, regulatory agencies sometimes treat them as debt if they have mandatory redemption features. Preferred shares typically lack voting power, limiting influence on corporate decisions.

Their sensitivity to interest rates is similar to bonds: when rates rise, their attractiveness decreases. Holders have priority in dividend payments, especially in financial distress. Some variants guarantee cumulative payments, ensuring compensation for missed dividends.

The Pros and Cons of Preferred Shares

Advantages:

• Predictable dividends, generally higher than common shares
• Greater security in case of company liquidation than common shares
• Attractive in low-interest-rate environments
• Portfolio diversification between fixed income and equities

Disadvantages:

• Limited capital appreciation potential
• Dividends may be suspended during financial crises
• No voting rights, reducing managerial influence
• Low liquidity, complicating sale
• Redemption clauses may restrict yields

Common Stock: The Growth Option

Common shares are the most issued type. They represent fractional ownership with higher growth potential compared to preferred shares, though with greater risk.

Classifications within Common Shares

Not all common shares are identical. Some companies issue:

• Non-voting shares: participation in profits without decision-making influence
• Multiple classes of shares: each class has different voting rights and dividends, allowing concentrated control even with a smaller percentage of shares

Specific Rights of Common Shareholders

The key attribute is voting rights at meetings, enabling influence over crucial decisions like director elections. In liquidation, common shareholders are paid after creditors, bondholders, and preferred shareholders. Their dividends fluctuate based on financial performance: they can be high in prosperous years or nonexistent during crises.

Strengths and Weaknesses of Common Shares

Advantages:

• High liquidity in main markets
• Significant appreciation potential
• Voting rights and corporate influence
• Direct link to business success

Disadvantages:

• Considerable price volatility
• Variable and unpredictable dividends
• Total loss risk in company bankruptcy
• Sensitivity to economic cycles and market conditions

Direct Comparison: Difference Table

How to Start Investing in These Shares

Practical steps:

1. Choose a regulated broker: Verify credibility, regulation, and user-friendly platform
2. Open your account: Complete personal and financial info, make initial deposit if needed
3. Research the company: Analyze financial statements, sector, trends, and outlook before buying
4. Place your order: Choose between “market orders” (current price) or limit orders (your target price)
5. Consider CFDs: Some brokers allow trading Contracts for Difference on these shares without owning them, depending on availability and liquidity

Essential recommendations:

• Diversify between common and preferred shares to balance risk and return
• Periodically monitor your portfolio
• Adjust your strategy based on market changes and personal situation

Strategy According to Your Profile: Common or Preferred?

For aggressive investors: Common shares are your allies. If you tolerate volatility and have a long-term horizon, growth potential justifies the uncertainty. They are ideal in mid-life stages of financial life where the goal is to multiply capital.

For conservative investors: Preferred shares offer stability. If you are capital preservation-oriented or nearing retirement, prioritize regular income over spectacular gains. The preference in dividends and liquidation provides security. They also serve as diversification tools, balancing fixed income and equities.

Real Case: The Preferred Market vs the General Market

The S&P U.S. Preferred Stock Index, which accounts for approximately 71% of the US preferred market, offers revealing perspective. Over five years, while the S&P 500 rose 57.60%, the preferred index fell 18.05%. This divergence illustrates how changing monetary policies affect them differently: when rates rise, preferred shares depreciate due to their fixed-income nature, while common stocks benefit from business growth.

Conclusion

Common and preferred shares do not compete; they coexist for different investment needs. A common stock is suitable if you seek growth and can tolerate volatility. Preferred shares are more appropriate for predictable income and lower risk exposure. The optimal strategy often combines both, adjusting proportions based on your age, financial goals, and risk capacity. Analyze your investor profile, research quality companies, and build a balanced portfolio that reflects your long-term objectives.