Choosing between Common Stock and Preferred Stock as per your Investment Profile

Which is a better investment option between common stock and preferred stock ?

An investor who would want to stay safe and not take any risk will go for preferred stock over common stock. He would take refuge in its safety and overlook its low profitability. An average investor on the other hand might find common stock more attractive and may be willing to take the risk of common stock in hopes of high returns.

Introduction to Common Stock Investing

 

A share of stock refers to a portion of the total equity capital of a public company. In layman terms it means you own a piece of the company and hence you are automatically eligible for a share of the profits. Hence a stock is an ownership of a part of the company. Having stocks in a company also entitles you to have a voting right to decide on the board members who manage and over see the decisions that the company takes. Common stocks do have high risks but they also have the potential to yield high dividend owing to high capital growth.

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What are the risks associated with Common Stocks?

Common stocks provide a high rate of return over long periods of time however they also have heavy risks involved. On an average they give dividends of about 11% and outscore all other bonds and securities. However stocks are the most susceptible to risks as they depend on the company. It is better to purchase stock in a company that is profitable and gives a good margin of dividend than to take a chance with a new company. If the company loses its money and goes bankrupt, there is a very good chance you may never recover your money.

 

Key Strengths of Common Stock Investments

Common stock is very easy to trade. With the advent of internet, data regarding companies is easily available on the net; it can easily be perused to make a well informed decision. There are large amounts of companies to choose for and invest in.

 

The unavoidable risk of placing everything at stake

There is no guarantee on your investment. The company might flourish and reward you with rich dividends. However it is equally likely that the company might go bankrupt too and you might lose not only the dividend but also your whole principal.

 

Introduction to Preferred Stock Investing

It also involves buying stocks of the company and is akin to owning a part of the company. They are a quite similar to common stock except ownership of this stock doesn’t give you any voting right in the company. With preferred stocks, the company promises a fixed dividend for a period of time. In some cases even varied dividends, albeit with certain preconditions. One of the major advantages with preferred stock holders is that if the company gets bankrupted, preferred stock holders are paid off before common stock holders. However the company has the right to buy them back from a stock holder at a cost. Preferred stocks are a cross between bonds and shares, and have qualities of both.

What are the key Strengths?

They gave higher dividend and also provide security against bankruptcy. Stockholders of preferred stocks are paid first when a company is liquidated.

Key Weaknesses of Preferred Stock Investing

They are taxable, higher returns are taxed more.

There are four types of preferred stocks

Participating preferred stock- These give the share holders the right to raised dividends if for a certain time period the common stock holder’s share of dividends exceeds that of the preferred stock holder’s dividends.

Adjustable-rate preferred stock- These are linked to Treasury bill. The dividend is decided based on the changes in interest rates, and calculated by a predetermined formula.

Convertible preferred stock- These can be converted into common stocks at the conversion price determined at the time of its sale.

Straight or fixed-rate perpetual stocks- These are issued without a maturity date with the dividend rate at a fixed rate for life.

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