How to Choose Between Preferred and Common Stocks: A Practical Guide for Investors

Publicly traded companies offer different classes of equity participation, each designed with specific purposes. The choice between preferred and common shares is a fundamental decision in any investment strategy, as they define both the level of control and the profitability profile each shareholder will obtain.

The Dual Nature of Preferred and Common Shares

Not all types of shares are the same. While common shares represent ordinary ownership with voting rights at meetings, preferred shares function as a hybrid instrument between traditional equity and debt instruments.

Preferred shares are characterized by offering fixed dividends or predetermined rates, regardless of whether the company is legally required to reimburse the invested capital. Variants include cumulative (where unpaid dividends are carried over to future periods), convertible (which can be transformed into common shares under certain conditions), redeemable (which the company can buy back), and participative (linked to financial performance).

Common shares, on the other hand, grant voting power but with variable returns depending on business performance. This volatility is both an opportunity and a risk: they can generate significant gains or substantial losses.

Rights and Priorities: The Financial Hierarchy

In a corporate structure, there is a clear hierarchy when a company faces liquidation. Creditors and bondholders have absolute priority, followed by preferred shareholders, who recover their investment before common shareholders.

Preferred shareholders enjoy stability because their dividends have priority. If the company faces financial difficulties, these payments are honored before any distribution to ordinary shareholders. However, this security comes at a cost: the lack of voting rights means these investors cannot influence critical corporate decisions such as the election of directors.

Common shares offer the opposite: full corporate influence but no income guarantees. Dividends fluctuate according to business performance, potentially being abundant in prosperous periods or eliminated entirely during crises.

Comparative Analysis: Profitability vs. Security

Sensitivity to interest rate changes significantly differentiates both instruments. Preferred shares, with fixed dividends, behave similarly to bonds: when rates rise, their relative attractiveness decreases. Common shares, in contrast, respond mainly to market volatility and business performance.

The growth potential of capital is limited in preferred shares but considerable in common shares. An investor purchasing common shares of a startup could see their investment multiply; a preferred shareholder will receive predictable but moderate returns.

Liquidity also makes a difference. Common shares of listed companies are frequently traded, allowing quick transactions. Preferred shares tend to have lower trading volume and may include restrictive clauses that complicate immediate sale.

Comparative Rights Structure

Market Outlook: Lessons from the S&P

Analyzing stock indices provides valuable perspective. Over a recent five-year period, the S&P U.S. Preferred Stock Index, which accounts for approximately 71% of the US preferred stock market, experienced an 18.05% decline. Simultaneously, the S&P 500 (which reflects common stocks) grew by 57.60%.

This divergence illustrates how changing monetary policies affect each instrument type. When interest rates rise, fixed dividends of preferred stocks lose relative attractiveness. Common stocks, linked to business growth, can better capture opportunities in an expanding market.

Investment Strategies by Profile

For growth-oriented investors: Common shares are more suitable. These individuals are generally in early or mid stages of their financial life, with a long-term horizon to absorb market fluctuations. They seek to maximize capital appreciation over the long term, tolerating volatility in exchange for potential substantial gains.

For conservative investors: Preferred shares offer an ideal solution. Typically in wealth preservation or approaching retirement phases, these investors prioritize regular, predictable income. They value lower risk exposure, priority in dividend distribution, and protection in liquidation scenarios.

Diversification strategy: Combining both types of shares in a balanced portfolio allows calibrating the risk-return trade-off. An investor can allocate a conservative portion to preferred shares while reserving capital for common shares of companies with attractive prospects.

How to Get Started in Stock Investment

The process of investing in preferred and common shares follows orderly steps:

Step 1: Choose a regulated platform. Select a broker that offers access to both classes of shares with verifiable regulation and competitive commissions.

Step 2: Open an investment account. Complete personal and financial data forms, making an initial deposit according to your available funds.

Step 3: Define your investment approach. Analyze target companies in detail: historical profitability, sector position, growth prospects.

Step 4: Execute orders. Use market orders (current price) or limit orders (specific price you set). Some brokers also offer CFDs on these shares, allowing exposure without direct ownership.

Key considerations: Diversify regularly, review your portfolio periodically, and adjust as market changes and your personal circumstances evolve.

Conclusion: Tailoring Your Decision to the Current Moment

Choosing between preferred and common shares is not binary but contextual. In low-interest-rate environments, preferred shares remain attractive due to their relatively high dividends. When robust economic growth is expected, common shares better capture those opportunities.

Historical data from the US market confirm this reality: while the S&P 500 tripled its growth compared to the preferred stock index during the analyzed period, both instruments remain useful depending on investment objectives and time horizon. The strategic decision is not about choosing one class over the other but about allocating an appropriate proportion to each based on your personal financial situation and specific investment goals.