Preferred Stocks: the safer way of buying stocks

Gold Star

Preferred stock gives a shareholder a more secure investment than common stock. Image: Flickr / criminalintent/ CC-BY-SA

Investing can be scary because it means taking a risk. One product that many beginning investors overlook, however, is a product called preferred stock.

Defining a preferred stock

Preferred stock is essentially a blend of a stock and a bond. Preferred stock is a commitment by a company to pay interest to shareholders, and generally this income is paid out first in cases where the company cannot pay out on both preferred and common stock. Preferred stock holders are second in line behind bond holders if the company runs into financial trouble. Preferred stock holders have rights to dividends, and the company must pay out preferred dividends before paying out common stock dividends.

Why preferred stock is better

Preferred stock usually pays out at a higher interest rate than many other securities. In the last few years, preferred stock has paid out between 5 and 8 percent in dividends. Preferred stocks also tend to be a much more stable price than common stocks. Preferred stocks also are easier to pull out of than certificates of deposit or other less risky securities.

[Some payday loan lenders offer shares on the stock market.]

Why preferred stock may not be a good choice

Preferred stock, even though it can be a less risky investment than common stock, is not always a good option. Preferred stock can be recalled by the issuer, which means that the company has the right to buy the stocks back if interest rates fall below a certain level in a certain amount of time. Preferred stock is also riskier than bonds, because bond holders are paid first, before preferred stock is paid out. Preferred stocks’ lack of volatility means you will likely not get much of a gain when you sell your preferred stock.

Do your research before purchasing

Before you purchase preferred stock, do your research. Legally, every company is allowed to structure its preferred stock in its own way. Most companies do not allow preferred shareholders to have a voting stake in the company. Voting rights are a big concern for some investors, so it is important to determine what you value most and if preferred shares would fit your investment needs best. Many preferred stock funds are close to full, so the best way to purchase preferred stock is to do so individually in each company; this can be time-consuming and difficult, but it also leads to an intimacy with your investments that may not be able to otherwise get.

Sources

USA Today
Investopedia
Money Crashers

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