Understanding the difference: Common and preferred stocks 

As an investor, you have many options when deciding where and how to invest your hard-earned money. Among the various investment options, two types that frequently surface in discussions are common stocks and preferred stocks. 

While both offer opportunities for potential growth, it is essential to grasp the nuances that set them apart to make informed and prudent investment decisions. By understanding their strengths and weaknesses, you can confidently navigate the complex world of investments and make the choices that align with your financial goals.

Understanding the difference: Common and preferred stocks 

Common stocks: An overview 

Common stocks are the most well-known form of stock. As a shareholder with common stock, you own a portion of the company and have the right to vote on matters that influence the business’s direction. This right to vote gives you a say in decisions such as electing the board of directors, mergers and acquisitions, and other significant corporate changes.

In addition to voting rights, common stocks offer the potential for capital appreciation. It means that if the company does well, your shares can increase in value. However, common stocks also come with risks. As an investor who buys stocks online in the UK, you are buying a share of the company’s ownership, which means that if the company performs poorly or goes bankrupt, your investment could lose value or become worthless.

Pros of common stocks 

 As mentioned earlier, investing in common stocks offers the potential for substantial capital appreciation, which could result in high returns for investors because the value of stocks can increase over time as the company grows and generates profits. However, it’s important to note that investing in stocks also comes with risks, as the value of stocks can also decline, leading to potential losses for investors. Therefore, it’s crucial to carefully research and analyse the companies before making investment decisions.

Owning a share of the company gives you an ownership stake and the ability to participate in corporate decisions. It can appeal to investors who want to engage actively in the companies they invest in. By holding shares, investors can have a say in electing board members, approving mergers or acquisitions, and voting on essential company proposals. Having voting rights gives investors a voice and influences the company’s direction, which can be a significant factor for those who want to align their investments with their values and beliefs.

Common stocks are known for their relatively high liquidity, which means they can be easily bought or sold in the market. It is because stocks are traded on stock exchanges, where buyers and sellers can come together to transact shares. High liquidity provides investors with the flexibility to enter or exit positions quickly, allowing them to take advantage of market opportunities or manage their investment portfolios efficiently. However, it’s worth noting that the liquidity of individual stocks can vary, and some stocks may have lower trading volumes or be less actively traded than others.

Cons of common stocks 

The stock market in the UK is subject to fluctuations, and common stocks are no exception. The value of your investment can go up and down depending on various factors such as economic conditions, company performance, and investor sentiment. Companies are not obligated to pay dividends to their shareholders. It means that even if a company is doing well, it may choose not to distribute profits in the form of dividends.

Preferred stocks: An overview 

Preferred stocks are a mix of common stocks and bonds. As with common stocks, investors own a portion of the company but do not have voting rights. In return, preferred stockholders receive a fixed dividend payment, much like bondholders.

Preferred stocks typically yield higher than common stocks and offer more stability as they are less volatile. They also take precedence over common stocks when receiving dividends or payouts in case of liquidation.

Pros of preferred stocks 

Preferred stocks offer more stability than common stocks as they provide a fixed dividend payment. It means that income-seeking investors can rely on a consistent income stream from their preferred stock investments, enhancing their financial security and providing a reliable source of cash flow.

In bankruptcy or liquidation, preferred stockholders are paid before common stockholders. This priority ensures that investors who hold preferred stocks have a higher chance of recovering their investment than those who hold common stocks. This preferential treatment gives preferred stockholders protection and reassurance in uncertain or adverse situations.

Preferred stocks typically have lower volatility than common stocks. This lower level of volatility makes preferred stocks more attractive to risk-averse investors who prefer a more stable and predictable investment. The reduced price fluctuations of preferred stocks can give investors greater security and peace of mind.

Cons of preferred stocks 

Preferred stockholders do not have a say in the company’s decisions. As mentioned, preferred stock prices do not usually appreciate significantly, meaning investors have less potential for returns than common stocks. Preferred stocks are generally less liquid than common stocks, meaning they can be harder to buy or sell.

Wrapping up

While both common and preferred stocks offer opportunities for potential growth, they have different characteristics that make them suitable for different types of investors. Common stocks can appeal to those seeking capital appreciation and active involvement in their investments, while preferred stocks can appeal to income-seeking and risk-averse investors.

Understanding the differences between these two types of stock is essential in making informed investment decisions that align with your financial goals. With this financial knowledge, you can confidently navigate the world of stock investing and build a diverse and resilient investment portfolio.