Pros and Cons: Preferred Stock vs Common Stock

Publicly traded companies typically offer shares of either preferred stock or common stock to investors. In general, companies are more likely to sell shares of common stock than preferred stock. Both can pay dividends, though there can be differences in how much is paid out and when. As an investor, choosing between preferred stock or common stock depends on your investment goals and whether you’re interested in having voting rights as a shareholder.

A financial advisor can help you evaluate all the factors that go into choosing preferred stock vs common stock.

What is Preferred Stock?

Preferred stock represents an ownership share. These shares can act like bonds, in that investors who buy in are usually offered a fixed dividend payout. Dividends are paid to investors on a set schedule for as long as they own shares of preferred stock.

As a result, preferred shares offer some predictability. When it’s time for dividends to be paid out, investors who own preferred stock are first in line, ahead of common stock shareholders.

However, preferred stock shares don’t have voting rights. That means they’re excluded from voting during shareholder meetings. For example, if a new board of directors is being elected a preferred stock shareholder wouldn’t have a say in who is chosen.

What is Common Stock?

Shares of common stock also represent an ownership stake in the underlying company. These shares can also pay out a dividend, though payment amounts and the timing for when they arrive is not fixed the way it is with preferred shares. Instead, common stock dividend payouts are set by the board of directors. But common stock shares do offer voting rights to shareholders. So that means if you own common stock, you have the opportunity to vote on key decisions.

The amount an investor receives can be tied to the company’s profitability for that particular dividend payout period. If you own common stock, you’ll receive your dividend payouts after preferred stock shareholders have been paid. It’s possible, however, that dividends associated with common stock shares could be reduced or eliminated altogether.

If a company’s profits shrink because of changing economic conditions, regulatory updates, or something else, that could affect its ability to pay out a dividend to common stock shareholders. However, with some companies, dividend payouts from common stock shares increase consistently over time. The Dividend Aristocrats, for example, represent the companies that have raised their dividend payout for 25 or more years consecutively.

Preferred Stock Pros and Cons

Investing in preferred stock shares can yield several advantages. On the pro side, some of the best reasons to consider preferred stock include:

Consistent dividend income, with fixed payout amounts and payment dates
First priority to receive dividend payouts ahead of common stock shareholders or creditors
Potential for larger dividends, compared to common stock shares

Aside from these benefits, some preferred stock shares may also be convertible. This means you can convert them to shares of common stock. That could make sense if you want to benefit from rising share prices. If you buy shares of preferred stock at one price and the common stock share price rises, you could convert some or all of your preferred shares to realize a capital gain.

The biggest con of preferred stock is the lack of voting rights although that depends on how invested you are in the company’s future. If you’re a hands-off investor by nature, then it may not matter as much.

Another potential downside to consider is the lack of liquidity. Common stock shares are more frequently traded in the marketplace so there’s always ready buyers. . If you want to sell your preferred shares, you may find it more difficult to liquidate them as quickly, which can be a problem if you’re facing a situation where you need your money ASAP.

Common Stock Pros and Cons

Just like preferred stock, there are both advantages and disadvantages associated with investing in common stock. Here’s what investors like about common stock:

Access. Companies generally issue more shares of common stock vs. preferred stock
Shareholders enjoy voting rights
Common stocks can offer more potential for long-term price appreciation

However, the biggest con of common stock compared to preferred stock is how dividends are paid and managed. They have lower dividend payouts, and those dividends may be paid out less consistently, too. Also, common stock shareholders only get paid after preferred stock shareholders do. So if a company goes bankrupt, for example, the preferred stock shareholders, creditors, and anyone else the company has to pay would take precedence over common stock shareholders. That means it’s possible you could walk away with nothing

On the other hand, investors who own common stock may benefit more over the long term if those shares increase in value. Investing in common stock may also be easier since you can purchase additional shares or invest in an index fund that allows you to hold a collection of common stocks.

How Dividends Work for Preferred vs. Common Stock

Dividends are a key difference between preferred and common stock, especially in terms of predictability and payout priority. Preferred stock typically offers fixed dividends that are paid on a regular schedule, while common stock dividends are variable and not guaranteed.

One important distinction within preferred dividends is whether they are cumulative or non-cumulative:

Cumulative preferred stock requires that any missed dividend payments must be paid out to preferred shareholders before any dividends can be paid to common shareholders.
Non-cumulative preferred stock does not require the company to make up missed payments, so if a dividend is skipped, investors lose that payment permanently.

During financial hardship or declining profitability, this difference becomes especially significant. If a company temporarily suspends dividend payments due to cash flow issues, holders of cumulative preferred stock are entitled to those missed dividends once payments resume. In contrast, common shareholders would not receive anything until all past and current preferred dividends are paid out in full.

For example:

A preferred stock may pay a fixed $2.00 per share annually, issued quarterly at $0.50 per share.
A common stock may pay a dividend that fluctuates based on profitability — for instance, $0.30 per share in one quarter, then $0.15 the next, or possibly none at all.

This consistency makes preferred stock attractive to income-focused investors, while common stock offers more variability but greater potential for dividend growth over time.

Tax Treatment of Preferred vs. Common Stock

Dividends from both preferred and common stock may be taxed differently, depending on whether they qualify as qualified dividends or ordinary income.

Qualified dividends are generally taxed at long-term capital gains rates, which range from 0% to 20% depending on your income level. Most common stock dividends qualify, provided you meet the holding period requirements.
Some preferred stock dividends, however, may not qualify for this favorable treatment. This is especially true for certain trust-preferred securities or foreign-issued preferred shares, which may be taxed as ordinary income, meaning up to 37% for high earners.

For high-income investors, this distinction can have a significant impact on after-tax returns. For example:

A $1,000 dividend from a common stock taxed at a 15% capital gains rate would yield $850 after tax.
That same $1,000 dividend from a non-qualified preferred stock could result in just $630 after tax at a 37% marginal income tax rate.

When evaluating preferred vs. common stock, it’s important to look beyond the dividend yield and assess the after-tax income based on how those dividends are classified. A financial advisor or tax professional can help you determine the most tax-efficient choices for your investment goals.

Should You Buy Preferred Stock vs. Common Stock?

If you want to have consistent dividend income over time, then preferred stock could be a better fit. The dividends may be higher than what you’d get with common stocks and, depending on the stock, you may have the option to convert your shares. Common stocks work better if you’re less interested in dividends than you are in long-term growth.

If you buy shares of common stock and that stock appreciates significantly over time, you could realize more of a benefit than you would from the dividends offered by preferred stocks.

Also, consider things like voting rights and payment priority. If you want to be actively involved in shaping the company’s policy or choosing who sits on the board, then you’d most likely want to choose common stock. But remember that investing in common stock means you’d be paid last if the company goes under, an important consideration if you’re investing in startups.

Bottom Line

While there are differences between preferred stock vs. common stock, one isn’t necessarily better than the other. Both have advantages, like guaranteed payouts, and disadvantages, like a lack of voting rights. Investing in a mix of each of one, not to mention other sorts of securities, could help with diversifying your portfolio to manage risk and rewards.

Tips for Investing

Whether you choose to invest in preferred stock vs. common stock shares, it’s important to consider things like taxes and fees to preserve as much of your returns as possible. If you’re unable to purchase individual stock shares in a tax-advantaged account, such as a 401(k), you could do so through an online brokerage account. When comparing brokerage accounts, consider the fees you’ll pay to invest. While more brokerages are offering commission-free trades for U.S. stocks and exchange-traded funds (ETFs), some do charge fees so be sure to understand what you’ll pay upfront.
Consider talking to a financial advisor about whether preferred stocks or common stocks make sense for your portfolio, based on your goals and risk tolerance. If you don’t have a financial advisor yet, SmartAsset’s financial advisor matching tool can help with finding one. You can get personalized recommendations for professional advisors in your local area. All it takes is answering a few brief questions to find your advisor match. If you’re ready, get started now.