The Practical Guide to Understanding Preferred vs. Common Stocks in Your Investment Strategy

When we decide to invest in preferred shares or common stocks, we are usually faced with a fundamental choice that determines our return and risk exposure. However, many beginner investors do not truly understand what difference exists between these two instruments beyond the name. Both are shares, but their rights, behaviors, and benefits are radically different.

Where to Start: The First Steps to Investing

Before choosing between preferred and common shares, you should follow a clear process:

1. Select a regulated platform: Find a reliable broker with a good reputation
2. Create your account: Provide personal and financial information
3. Define your risk profile: Analyze how much volatility you can tolerate
4. Execute orders strategically: Use market or limit orders as appropriate
5. Consider alternatives like CFDs: Many platforms offer difference trading without owning the shares

This initial framework is crucial before delving into which type of share best suits your objectives.

Anatomy of Common Shares: Growth vs. Volatility

Common shares represent fractional ownership in a company. They are the most familiar instrument in markets, but also the one that requires greater risk tolerance.

Distinctive features:

• Grant voting rights in important corporate decisions
• Their dividends fluctuate according to the company’s financial performance
• In case of insolvency, they are last in line to receive compensation
• Offer greater potential for capital appreciation

The liquidity of common shares is generally high, allowing quick transactions in main markets. However, their prices are subject to market volatility, influenced by economic and corporate factors. Investors who buy common shares typically seek long-term growth, accepting fluctuations as part of the process.

Preferred Shares: Predictable Stability with Limitations

When we talk about investing in preferred shares, we refer to a hybrid instrument that combines features of debt and equity. They are recorded as equity on the books, but function differently from common shares.

Main attributes:

• Generate dividends at a fixed or pre-established rate, often cumulative
• Do not grant voting rights, limiting influence on corporate decisions
• Have priority over common shares in liquidation (although below creditors)
• Sensitive to changes in interest rates, resembling bonds

There are multiple variants: cumulative ones preserve unpaid dividends; non-cumulative ones lose them; convertible ones can be transformed into common shares; and redeemable ones can be repurchased by the company.

Key Differences Table

Why Investors Choose Each Type

For common shares: Investors with an aggressive profile and long-term horizon opt for this instrument. They seek to accumulate capital through price appreciation, accepting that dividends may be inconsistent. These individuals, often in early stages of their financial life, prioritize growth over security.

For investing in preferred shares: Conservative investors, often in retirement years or capital preservation, prefer these shares. They value predictable income streams and risk reduction. Combining preferred and common shares in a portfolio allows balancing risk exposure while maintaining relatively stable returns.

Market Behavior: A Lesson in Contrast

The comparison between the S&P U.S. Preferred Stock Index and the S&P 500 clearly illustrates how these instruments behave. Over a five-year period, the S&P 500 increased by 57.60%, while the preferred stock index fell 18.05%. This divergence is not accidental: it reflects how changes in monetary policy affect these assets differently.

The S&P U.S. Preferred Stock Index, which accounts for approximately 71% of the traded preferred stock market in the U.S., is an important benchmark. Its decline during periods of rising interest rates demonstrates that, although they offer stability, preferred shares are vulnerable to specific macroeconomic changes.

Advantages and Disadvantages Compared

Common Shares:

• Advantage: unlimited growth potential, high liquidity, corporate influence
• Disadvantage: considerable volatility, inconsistent returns, risk of total loss

Preferred Shares:

• Advantage: predictable income, lower volatility, priority in liquidation
• Disadvantage: limited growth potential, restricted liquidity, lack of voting power, complicated redemption clauses

Recommended Strategy: Smart Diversification

The best approach is not to choose one over the other, but to combine them strategically. A diversified portfolio mixing common shares for growth and preferred shares for stability creates a balanced profile. This strategy adapts to different life stages: more aggressive in youth, more conservative in maturity.

Regularly monitor your investment, adjust your strategy according to market changes, and remember that investing in preferred shares is a valuable option not as a sole instrument, but as part of a comprehensive plan.