Preferred Stocks vs Common Stocks: What Most People Get Wrong

You’re staring at your brokerage account. There’s a ticker symbol you recognize, but it has a weird suffix like "-PR" or ".PA" attached to it. That’s the world of preferred shares. Most people just buy common stock and call it a day, but if you’re hunting for income or trying to protect your downside in a shaky market, you’re looking at the wrong thing. Preferred stocks vs common stocks isn't just a technicality for accountants; it’s a fundamental choice about how you want to get paid and what kind of risk you’re willing to stomach.

Honestly, the names are kinda misleading. "Preferred" sounds like it’s better, right? Like a VIP pass. But in the stock market, being a VIP usually means you’re giving something up to get something else.

The "Hybrid" Nature of Preferred Shares

Think of common stock as the "all-in" bet on a company. You own a piece of the pie. If the company becomes the next Nvidia, your shares skyrocket. You get to vote on who sits on the board. You’re an owner, plain and simple.

Preferred stock is more like a corporate "I owe you" wrapped in a stock certificate. It’s a hybrid. It acts like a bond because it pays a fixed dividend, but it trades on an exchange like a stock. Most preferreds have a "par value"—usually $25—and they tend to hover around that price. They don’t capture the massive "moon mission" gains of common stock. If a company's value triples, the preferred stock might only nudge up a few percentage points.

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Why would anyone want that? Income. While common dividends can be cut the moment a CFO gets nervous, preferred dividends are much stickier.

The Waterfall of Getting Paid

If a company goes bust, there’s a very specific order for who gets the remaining cash. This is the "liquidation preference."

1. Bondholders and banks (the debt) get paid first.
2. Preferred stockholders are next in line.
3. Common stockholders get whatever is left. Usually, that’s zero.

In a crisis, that "preference" matters. It’s the difference between a total loss and getting some pennies back. But even in good times, the "preference" applies to dividends. A company literally cannot pay a single cent to common shareholders unless they have fully paid the agreed-upon dividend to the preferred holders.

Voting Rights and the Power Gap

Common stockholders get the vote. One share, one vote (usually). You get those thick proxy statements in the mail asking you to vote on executive pay or board members. Preferred shareholders? They generally have zero voting rights. You’re a silent partner. You’ve traded your voice for a steady check.

For the average retail investor, voting rights are mostly symbolic anyway. Unless you’re Carl Icahn, your 100 shares of Apple aren’t swinging an election. But for institutional investors, this power gap is a major factor in how they price preferred stocks vs common stocks.

The Cumulative Catch

Here is a nuance that catches people off guard: Cumulative dividends.

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Most preferred stocks are "cumulative." If a company hits a rough patch and misses a dividend payment, they don't just get to move on. They owe that money. It piles up on the balance sheet as an "arrearage." Before they can ever resume paying the common dividend, they have to write a massive check to the preferred holders to cover everything they missed.

Some preferreds are "non-cumulative," though. These are common in the banking sector (think JPMorgan or Wells Fargo). If they miss a payment, it’s gone forever. You need to read the prospectus. It’s boring, but it’s where the trap doors are hidden.

Interest Rate Sensitivity: The Hidden Danger

Common stocks are driven by earnings and growth. Preferred stocks are driven by interest rates.

Because preferreds pay a fixed dividend, they act like long-term bonds. When the Federal Reserve hikes rates, the "fixed" yield on an old preferred share looks less attractive. People sell them to buy new things with higher yields. The price drops.

In 2022 and 2023, when rates spiked, many "safe" preferred stocks saw their prices crater by 20% or more. Common stocks fell too, but for different reasons. If you bought preferreds thinking they were a "cash alternative," you probably got a nasty surprise. They are sensitive. Really sensitive.

Tax Advantages You Might Be Missing

Here’s something most people get wrong: The tax treatment.

Interest from bonds is taxed as ordinary income. That can be as high as 37%. However, most dividends from preferred stocks vs common stocks are "qualified dividends." This means they are taxed at the lower capital gains rate (0%, 15%, or 20% depending on your income).

For a high-earner, a 6% preferred yield might actually put more money in your pocket than a 7% bond yield after the IRS takes its cut. It’s one of the few ways to get "bond-like" income with "equity-like" tax perks.

Call Risk: The Company’s Escape Hatch

Most preferred stocks are "callable." This means after a certain date (usually five years after they are issued), the company has the right to buy them back from you at par value.

Imagine you bought a preferred stock at $23 that pays an 8% dividend. Life is great. But then interest rates drop to 4%. The company realizes they are overpaying you. They "call" the stock, pay you $25, and take your 8% yield away. You’re left with cash in a low-interest world. This "call risk" puts a ceiling on how high the price of a preferred stock can go.

Real-World Examples

Look at a company like Bank of America (BAC).

• The Common Stock (BAC) fluctuates wildly based on the economy, loan growth, and market sentiment. It pays a modest dividend that grows over time.
• The Preferred Stock (like BAC-PrL) pays a much higher yield, often 5-6%, but its price stays relatively flat.

In a bull market, the common stock wins by a mile. In a flat or slightly down market, the preferred stock often provides a much better total return because that 6% check keeps hitting your account every quarter regardless of what the headlines say.

Which One Should You Buy?

It depends on your "why."

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If you are 25 years old and building a nest egg, ignore preferreds. You need the growth that only common stock provides. You want the "unlimited" upside. Preferreds will just drag your long-term performance down because they don't compound the same way.

If you are 60 years old and need to live off your portfolio, preferreds are a godsend. They offer higher yields than the common stock and more stability than the "junk bond" market. They help you bridge the gap between "too risky" and "too boring."

Actionable Strategy for Investors

1. Check the "Yield to Call": Don't just look at the current yield. If a stock is trading at $26 but has a call price of $25, you could lose $1 per share the moment the company decides to redeem it.
2. Diversify via ETFs: Picking individual preferreds is hard because of the weird terms (floating rates, fixed-to-float, etc.). Look at funds like PFF (iShares Preferred & Income Securities ETF) or PGX (Invesco Preferred ETF). They spread the risk across hundreds of issues.
3. Watch the Fed: If you think interest rates are going to fall, it’s a great time to buy preferreds. You lock in a high yield, and the share price will likely rise.
4. Credit Ratings Matter: Unlike common stock, preferreds are rated by agencies like Moody’s and S&P. Stick to "Investment Grade" if you actually want the safety you’re paying for.

Understanding preferred stocks vs common stocks isn't about finding one "winner." It's about knowing which tool to use for the job. Common stock is your engine for wealth creation; preferred stock is the steady heartbeat of an income-focused portfolio. Know the difference before you click "buy."