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20 Investments: Preferred Stock
What Is It?
Preferred stock represents ownership in a company, but it usually does not give the holder voting rights (this may vary depending on the company). With preferred shares, investors are guaranteed a fixed (or sometimes variable) dividend forever, while common stocks have variable dividends. One of the main advantages to being a preferred stockholder is that, should the company experience financial trouble and have to liquidate, you would be paid off before the common stockholders (but still after debt holders).
Preferred stock may also be callable, meaning that the company has the option to purchase the shares from shareholders at any time - and usually for a premium.
While certainly not as popular as common stock, preferred shares are offered by a wide range of companies. It is important to remember that even though preferred shares are known as a type of stock, they are really more of a cross between a stock and a bond.
Objectives and Risks
The major objective of a preferred stock is to provide a much higher dividend than that provided by common stock. Preferred stock is also much less volatile than common stock and less risky if the company goes bankrupt - a preferred shareholder is far more likely than a common shareholder to get at least some of his/her money back. As a company liquidates, bondholders are paid first, followed by preferred shareholders. Common shareholders are at the bottom of the ladder.
How To Buy or Sell It
Preferred stock trades the same way as common stock, usually through a brokerage, either full service or discount. Commissions to buy preferred stock are usually the same as common stock fees. There is no minimum investment for most preferred stocks, but many brokerages require clients to have at least $500 to open an account. (To learn more, see our Stock Basics Tutorial.)
Strengths
Dividends are higher than those of common stocks.
If the company goes bankrupt, you have a better chance of getting some money back than common shareholders. |
Weaknesses
Dividends are taxed at the same rate as income, so higher dividends mean you will likely pay more taxes.
Rates of return on preferred stock are very close to those for corporate bonds, and corporate bonds are considered less risky. |
| Three Main Uses
Provides Income
Capital Appreciation
Lower Risk | Next: 20 Investments: Real Estate & Property
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