How to choose between preferred and common stocks: a guide to maximize your investment

When you decide to invest in the stock market, one of the most critical decisions is determining which type of instruments best fit your profile. Common and preferred shares represent two different paths within the same equity market, each with profound implications for your wealth and financial strategy.

Why are there two categories of shares

Public companies issue multiple classes of shares with unequal rights. This practice responds to a need: to raise capital from investors with very different risk tolerances. While some seek active participation and exponential growth, others prioritize stability and guaranteed periodic income.

The share structure is designed precisely to satisfy both profiles simultaneously. Understanding this architecture is essential before investing money.

Ordinary shares: the vehicle for growth

Common shares are the traditional mechanism through which an investor acquires fractional ownership of a company. Their main appeal lies in the potential for capital appreciation linked to corporate performance.

Rights inherent to common shares

When you own common shares, you gain decision-making power. You have voting rights at shareholder meetings, allowing you to influence relevant corporate matters, such as the appointment of the board of directors or major strategic decisions.

Regarding dividends, these vary considerably. During periods of high business profitability, payments can be substantial. However, in contexts of economic contraction or operational challenges, the company may drastically reduce or eliminate these distributions.

In case of corporate insolvency, as a holder of common shares, you occupy a position at the end of the creditor queue. Only after banks, bondholders, and preferred shareholders recover their investments will you have access to remaining assets.

Advantages and limitations of investing in common shares

Liquidity is a fundamental strength. In developed markets, you can execute buy and sell orders quickly, accessing your capital without significant delays.

The potential for appreciation is considerable when the company experiences sustained growth. Investors who entered tech companies fifteen years ago multiplied their initial capital exponentially.

However, volatility presents a significant challenge. Price fluctuations can be abrupt and disconcerting, especially during macroeconomic uncertainty cycles. An investor with low emotional tolerance will face considerable difficulties.

Additionally, dividends are not guaranteed. Young companies in expansion phases often reinvest all profits without distributing anything to shareholders.

Preferred shares: the alternative of predictable income

On the opposite end are preferred shares, a hybrid category combining features of debt and equity. They are classified as equity on the books but operate with logic similar to fixed-income instruments.

Structure and types of preferred shares

There are multiple variants designed for specific cases:

Cumulative preferred shares: Missed dividends in previous periods accumulate and must be paid in full before any other distributions. This feature offers greater security to the investor.

Redeemable preferred shares: The company retains the right to buy them back at predetermined times, which limits your holding horizon.

Convertible preferred shares: Under specified conditions, they can be converted into common shares, combining initial stability with potential for future growth.

Participating preferred shares: Dividends are directly linked to financial results, allowing beneficiaries to share in exceptional performances.

Rights and protections of preferred shares

Here lies the most evident distinction: preferred shares DO NOT grant voting rights. You waive corporate influence in exchange for other benefits.

Dividends are generally fixed at a set percentage or predetermined rate. If the company sets a 5% annual return, that will be your yield regardless of whether it earned millions or faced difficulties.

In liquidation scenarios, your position is superior to that of common shareholders. You will receive compensation before them, but after creditors and bondholders.

These shares are sensitive to interest rate changes. When central banks raise rates, the relative attractiveness of fixed-dividend preferred shares diminishes.

Strengths and weaknesses of preferred shares

Predictable income is the main advantage. In low-interest-rate environments, these fixed dividends are especially attractive compared to bank deposits or bonds.

The risk is substantially lower than in common shares. The company has a strong incentive to maintain these payments, as defaulting would affect its credit rating.

However, appreciation potential is limited. Your gains are confined to periodic dividends; you will not benefit from extreme upward movements.

Liquidity can be problematic. Many preferred shares trade with lower volumes, which can hinder your quick exit from the market. Additionally, redemption clauses may force you to sell at inconvenient times.

Quantitative comparison: market evidence

The S&P U.S. Preferred Stock Index, which accounts for approximately 71% of the U.S. preferred stock market, offers revealing perspective. Over a five-year horizon, this index experienced an 18.05% decline, while the S&P 500 (which groups common stocks of large companies) increased by 57.60%.

This divergence is no coincidence. It reflects the sensitivity of preferred stocks to monetary policy changes. When central banks begin rate hike cycles, the relative value of these fixed-income instruments compresses.

Simultaneously, common stocks of resilient business models capitalized on the underlying economic growth.

Strategies based on your investor profile

If you are young or middle-aged with the capacity to tolerate fluctuations: Common stocks aligned with regular shares are the engine of wealth accumulation. Your long-term horizon allows you to weather volatility and benefit from compound growth.

If you are nearing retirement or need consistent cash flow: Preferred shares offer peace of mind. You sacrifice potential wealth explosion in exchange for predictable income that funds daily expenses.

A sophisticated strategy combines both categories. Structure a portfolio where 60-70% corresponds to common shares and 30-40% to preferred shares, balancing growth with stability according to your age and objectives.

Practical path: from theory to effective investing

The process begins by selecting a reliable intermediary. Verify that it is regulated by relevant financial authorities and offers competitive conditions in commissions.

After opening your account (process requiring identity documents and initial funds), spend time researching specific companies. Analyze their financial statements, sector of operation, competitive position, and macroeconomic trends affecting them.

Execute your order specifying whether you want to buy at the current price (“market order”) or set a maximum price you are willing to pay (“limit order”).

Advanced alternative: some intermediaries allow trading via CFDs (contracts for difference), derivative instruments that replicate price movements without requiring physical ownership of shares. This mode involves amplified risks and requires prior experience.

Summary: building your investment decision

Choosing between common and preferred shares is not binary but contextual. Your age, financial goals, emotional risk tolerance, time horizon, and liquidity needs determine the optimal structure.

Common shares offer transformative potential for long-term wealth builders. Preferred shares provide peace of mind for conservative income seekers.

Inves­tor maturity involves recognizing that both have a legitimate place in a balanced portfolio, each fulfilling a specific function within your comprehensive financial architecture.