What is a Preferred Stock

Preferred Stock has been available to investors alongside common stock from the beginning but many retail investors don’t even know what it is (or how to invest in it). Sometimes called preferred shares, these stocks don’t have voting rights but have priority over common stock in dividend payout and also in the case that the company goes bankrupt.

Features of Preferred Stock

Normally, the main reason why people buy preferred shares is due to its preferred treatment when it comes to dividends. Other features include:

  • Preferred shareholders are compensated before common stock holders in the event of a company’s liquadation
  • Preferred shares usually come with a fixed dividend amount, but it can sometimes be a variable rate
  • They usually don’t come with voting rights, although some come with rights as well

Disadvantages

Some say that preferred stock has the disadvantage of bonds as well as common stock but don’t have the advantages of any.  They argue that like bonds, prefers don’t grow in value when the company does well but unlike bonds, the value of a preferred can go down because there are no maturity dates.  (remember that bonds prices go down when interest rate go up, but the prices usually creep back up as maturity dates approaches).

How Do I Buy Preferred Stock

In general, a brokerage account gives you access to publicly listed preferred stock, which is only limited to financial institutions, REITs and public utilities.  They trade like common stock so you can buy and sell whenever markets are open.

What this Mean for Us

I remember my dad buying preferred shares when I was young.  Ultimately, he was buying them because it provided a good income stream as long as he had the capital to hold it forever (if needed).  If he needed to sell it, the interest rates better not be rising because it would kill the value of his shares.

Owning preferred shares is also better than owning bonds if the interest rates are the same in a tax perspective.  IRS taxes bond’s interest at the income tax rate, while dividends are taxed at a maximum of 15%.

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