Do you know the real difference between common and preferred shares?

When you enter the world of investing, one of the first dilemmas is choosing between common and preferred shares. Do they seem the same? No. Each plays a different role in your portfolio and suits completely different financial goals. Understanding these nuances is key if you want to make smart decisions.

Two parallel worlds: common shares vs preferred shares

Companies do not issue a single type of share. In fact, they can create different instruments, each with its own rights and characteristics. The two most relevant are common shares and preferred shares, and although they seem like siblings, their behaviors are almost opposite.

Common shares: are the backbone of the stock market. They allow you to vote on key company decisions, participate in variable profits, and in case of bankruptcy, you are entitled to what remains. The trade-off: guaranteed volatility.

Preferred shares: here, the game is different. You do not vote, but in exchange, you receive more stable dividends and, in case of liquidation, you get ahead in the compensation queue (although behind creditors).

Preferred shares: predictable returns with restrictions

Preferred shares occupy a unique space in the corporate financial structure. They are strangely hybrid: they retain debt-like features (fixed dividends) but function as equity on the books. The result? An instrument that attracts investors seeking regular income.

Varieties of preferred shares that exist

Not all are the same. Within this universe, we find:

• Cumulative: unpaid dividends pile up and are paid later
• Non-cumulative: missed dividends are lost, with no right to recover
• Convertible: can be transformed into common shares under certain terms
• Redeemable: the company can buy them back at its convenience
• Participating: dividends fluctuate with the company’s financial results

What rights do you get by owning preferred shares

This is where the magic begins. Holders of preferred shares enjoy priority in dividend payments over common shareholders. If the company generates limited profits, you get paid first.

In liquidation, your position is superior to any common shareholder, although behind bondholders and creditors. However, you give up voting rights, which limits your influence on crucial corporate decisions.

Another relevant feature: they are sensitive to changes in interest rates, similar to bonds. If rates rise, the appeal of your fixed dividends diminishes.

The positive and negative side of these shares

Advantages:

• Predictable dividends and generally higher than common shares
• Greater security in case of corporate bankruptcy
• Attractive in low-interest-rate environments

Disadvantages:

• Limited potential for appreciation
• No voting rights on corporate decisions
• Restricted liquidity, with redemption clauses complicating sales
• Dividends can be suspended during financial crises

Common shares: growth with turbulence

Common shares are the bet on growth. They represent a real stake in the company and, unlike preferred shares, offer a much more attractive capital gain potential.

Structure of common shares

Although they seem homogeneous, there are variants:

• No voting rights: you receive benefits but without influence on decisions
• Multiple classes: each class offers different voting rights and dividends, allowing certain groups to maintain control with less ownership

Rights of being a common shareholder

The voting right is your power. You can influence critical decisions: election of directors, business strategy, profit distribution.

In liquidation, your priority is lower: creditors are paid first, then bondholders, then preferred shareholders, and finally you. But if the company does well, your dividends can be substantially higher.

Strengths and weaknesses of common shares

Strengths:

• High liquidity in main markets
• Significant potential for capital appreciation
• Voting rights in corporate decisions
• Direct exposure to corporate growth

Weaknesses:

• Price volatility influenced by company performance and market conditions
• Variable dividends dependent on profitability
• Higher risk of loss compared to preferred shares
• In crises, you might receive reduced or no dividends

Side-by-side comparison: common vs preferred shares

How to start investing in common and preferred shares

Step 1: Choose a reliable broker
Look for regulated platforms with a proven track record. Trust is your first asset.

Step 2: Open your account
Complete identity verification, provide financial data, and make an initial deposit.

Step 3: Design your strategy
Analyze the company: numbers, sector, trends. It’s not a game of chance.

Step 4: Execute your order
Market orders (current price) or limit orders (specified price). You can also trade CFDs on these shares if your broker offers them.

Practical recommendations:

• Diversify by combining both types
• Review your portfolio periodically
• Adjust your strategy based on market changes
• Understand your risk tolerance before investing

Investor profile: what’s your path?

If you seek aggressive growth: common shares are your territory. They require a long-term horizon and nerves of steel, but the return potential justifies the volatility. Typically attracts early or mid-stage investors in their financial life.

If you prioritize stability: preferred shares fit better. They are ideal for those approaching retirement or needing predictable cash flows. They offer less volatility, greater certainty in dividends, and better protection in crises.

Some smart investors combine both: common shares for growth and preferred shares for stability, balancing risk and return in a single portfolio.

The numbers speak: preferred stock market vs the overall market

To gauge the relevance of these instruments, look at index contrasts. The S&P U.S. Preferred Stock Index, which accounts for approximately 71% of the preferred stock market in the U.S., fell 18.05% in five years. In the same period, the S&P 500 rose 57.60%.

What does this tell us? During expansive monetary policy, fixed dividends lose appeal. Common shares capture market dynamism. But when uncertainties arise, investors seek refuge in predictable dividends offered by preferred shares.

The lesson: understanding these differences between common and preferred shares is not just theory; it’s your compass to navigate market cycles.

Conclusion: choose according to your reality

There is no universal answer. Common and preferred shares serve different purposes. Your choice depends on your age, financial goals, risk tolerance, and time horizon. Sophisticated investors recognize that both have a place in a well-constructed portfolio. The art is in finding your balance.