Common Vs. Preferred Stocks - Difference

When it comes to investing in the stock market, one of the fundamental decisions investors face is choosing between common Vs. preferred stocks. While both types of stocks represent ownership in a company, they have distinct characteristics and features that can impact an investor’s investment strategy and risk tolerance. In this blog, we’ll explore the difference between common stocks and preferred stocks to help you make informed decisions about your investment portfolio.

Common Vs. Preferred Stocks – Difference

	Common Stocks:	Preferred Stocks:
1	Ownership: Common stocks represent ownership in a company and given shareholders voting rights at shareholder meetings. As partial owners of the company, common shareholders have the right to elect the board of directors and vote on important corporate decisions.	Priority in Dividend Payments: Preferred stocks typically come with a fixed dividend payment that is paid out to shareholders before any dividends are distributed to common shareholders. This gives preferred shareholders priority over common shareholders in receiving dividend payments, providing a level of income stability and security
2	Dividends: Companies may choose to distribute a portion of their profits to shareholders in the form of dividends. However, common shareholders do not have a guaranteed dividend payment and are only entitled to dividends if the company’s board of directors declares them. Dividend payments to common shareholders are typically variable and can fluctuate based on the company’s financial performance and dividend policy.	No Voting Rights: Unlike common stocks, preferred stocks generally do not come with voting rights at shareholders’ meetings. Preferred shareholders do not have a say in corporate governance matters or the election of the board of directors.
3	Capital Appreciation: Common stocks offer the potential for capital appreciation, meaning the value of the stock can increase over time. Investors can profit from common stocks by selling their shares at a higher price than they paid for them. However, common stocks also carry the risk of capital loss if the stock price declines.	Less Volatility: Preferred stocks tend to be less volatile than common stocks because of their fixed dividend payments and priority in dividend distributions. They are often considered hybrid securities, combining characteristics of both stocks and bonds.

Additional Considerations to select between Common Vs. Preferred Stocks

Tax Treatment:

Another important consideration when comparing common stocks and preferred stocks is their tax treatment. Dividend income from common stocks is typically taxed at the ordinary income tax rate, which can vary depending on your tax bracket. On the other hand, dividends from preferred stocks may qualify for preferential tax treatment, such as being taxed at the lower long-term capital gains tax rate for qualified dividends. This tax advantage can enhance the after-tax return on investment for preferred stockholders.

Convertible Features:

Some preferred stocks come with convertible features that allow shareholders to convert their preferred shares into a predetermined number of common shares at a specialized conversion ratio. This feature provides flexibility for investors who may want to capitalize on the potential upside in the company’s common stock while still benefitting from the stability of preferred dividends. However, it’s essential to consider the conversion terms and potential dilution effects on existing shareholders when evaluating convertible preferred stocks.

Credit Risk:

Preferred stocks are often issued by companies with lower credit ratings or in industries prone to volatility, such as financial services or utilities. As a result, preferred stockholders may face higher credit risk compared to common stockholders, particularly in the event of bankruptcy or financial distress. Investors should assess the creditworthiness of the issuing company and consider the potential impact of credit risk on the stability of preferred stock dividends.

Liquidity:

While common stocks typically have higher trading volumes and liquidity compared to preferred stocks, the liquidity of preferred stocks can vary depending on market demand and issuer-specific factors. Preferred stocks may trade less frequently and have wider bid-ask spreads, making them less liquid investments. Investors should be mindful of liquidity considerations when incorporating preferred stocks into their portfolios, especially if they may need to sell their shares quickly in response to changing market conditions.

Risk-Return Profile:

Ultimately, the choice between common stocks and preferred stocks should be guided by ones risk-return profile and investment objectives. Common stocks offer the potential for higher returns but come with greater volatility and risk. Preferred stocks provide stable income and downside protection but may offer lower growth potential. By assessing your risk tolerance, income needs, and portfolio diversification goals, you can determine the optimal allocation between common and preferred stocks to achieve your long-term investment objectives.

Conclusion – Common Vs. Preferred Stocks:

In Conclusion, common Vs. preferred stocks offer distinct advantages and trade-offs for investors seeking to build diversified investment portfolios. By considering the factors above, investors can make informed decisions about incorporating common and preferred stocks into their investment strategies. Whether you prioritize growth, income, or capital preservation, understanding the nuances of each asset class is essential for constructing a resilient and well-balanced portfolio that aligns with your financial goals.