Common Stock vs Preferred Stock: Choosing the wrong one can result in double the difference in returns

It’s not all stocks are the same. Corporate issued common shares and preferred shares may seem like ownership certificates, but in reality, they are two completely different investment tracks. Over five years, the S&P 500 increased by 57.60%, while the U.S. Preferred Stock Index actually fell by 18.05% — same market, why such a big difference? The core lies in the fundamentally opposite logic behind these two types of stocks.

Who should choose common stocks? Who should choose preferred stocks?

If you are this type of investor, choose common stocks:

• Young, with 20-30 years of investment horizon
• Able to tolerate over 50% stock price fluctuations
• Want to participate in company decisions (exercise voting rights)
• Pursuing capital appreciation rather than fixed income

If you prefer stable income, preferred stocks are more suitable:

• Approaching retirement or already retired
• Need regular cash flow
• Can accept little to no stock price growth
• Hope to have priority claims in company liquidation

Preferred Shares: A “Quasi-Bond” Stock

Preferred stocks are a bit special — they are not fully stocks nor fully bonds, but a hybrid product between the two.

What is their core feature? Fixed dividends.

Dividends on common stocks depend on company performance — profit means dividends, loss means no dividends. But preferred stocks differ; they commit to paying dividends at fixed or pre-set rates. Even more aggressively, some preferred stocks promise cumulative dividends: unpaid dividends from previous years must be made up in the current year, with no default allowed.

This is why conservative investors love them — predictable returns. But what’s the cost? No voting rights. You cannot participate in shareholder meetings to decide major company matters; you just sit and collect dividends.

How many types of preferred stocks are there?

• Convertible preferred stocks: can be converted into common shares under certain conditions, so if the company takes off, you can ride the wave
• Redeemable preferred stocks: the company can buy them back at an agreed price, giving the company an “exit option”
• Participating preferred stocks: if the company earns huge profits, besides fixed dividends, you can also share in the upside

Why are preferred stocks so sensitive to interest rates?

The attractiveness of preferred stocks depends on their yield. When the central bank cuts rates, a fixed 5% dividend becomes attractive; but when rates rise to 6-7%, who still wants 5% preferred stocks? The market will devalue them. That’s why in 2020-2021, when bond yields surged, preferred stocks collectively declined.

Common Stocks: A Double-Edged Sword of Risk and Return

Common stocks are the most “democratic” — you can vote, receive dividends, and have unlimited upside potential. But this freedom comes at a cost.

Three main advantages of common stocks:

1. Voting rights: you’re not just investing money, but also have a say. Who to elect as directors, strategic decisions — you participate
2. Unlimited appreciation potential: in theory, a stock can rise from $10 to $100, even $1000. Preferred stocks cannot do this; their price ceiling is basically the inverse of yield
3. High liquidity: common stocks have large trading volumes, easy to sell without trouble

But what about risks?

• Price volatility: a bad news can drop 20%, those with weak risk tolerance may cut losses at the bottom
• Unstable dividends: if the company loses money, dividends may be cut or completely suspended
• Lowest priority: in bankruptcy, all creditors and preferred shareholders are paid first; when it’s your turn, you might get nothing

Key differences at a glance

Data speaks: S&P 500 vs S&P U.S. Preferred Stock Index

This comparison best illustrates the point. Over the past five years (2019-2024), the two indices have taken completely different paths:

• S&P 500: +57.60% (winner among common stocks)
• S&P U.S. Preferred Stock Index: -18.05% (victim of rising interest rates)

Why? Because in 2022-2023, the Fed aggressively raised interest rates. When the risk-free rate jumps from 0.5% to 5%, preferred stocks offering only 3-4% fixed returns become unattractive. Meanwhile, rising interest rates hit bond prices harder (bond prices move inversely to yields), so preferred stocks also decline.

But this doesn’t mean preferred stocks are “bad.” It just means that in a high-interest environment, cash management tools (like money market funds) become more attractive. When rates fall again, preferred stocks will shine again.

Practical advice: how to choose and allocate

Step 1: Assess your financial stage

• Accumulation phase (ages 20-45): 80% common stocks + 20% preferred stocks
• Balance phase (ages 45-60): 50% common stocks + 50% preferred stocks
• Retirement phase (60+): 20% common stocks + 80% preferred stocks

Step 2: Choose trading platforms

Any legitimate licensed broker can trade both types of stocks. Account opening steps:

1. Submit identity and financial info
2. Deposit funds
3. Place orders (market or limit orders)

If you want to avoid holding stocks directly, you can also consider CFD (Contract for Difference) trading on certain preferred stocks, but ensure the platform supports it and liquidity is sufficient.

Step 3: Monitor and adjust

Don’t buy and forget. Review quarterly:

• Whether preferred dividends have been cut
• Changes in the fundamentals of your common stocks
• Significant shifts in interest rate environment

If interest rate trends reverse, you may need to reallocate.

Final words

Common stocks and preferred stocks are not “one good, one bad,” but “fit different goals.” Young investors should rely on common stocks to accumulate wealth; those nearing retirement may find preferred stocks more reassuring. The real experts hold both and adjust their allocations dynamically based on market conditions — increasing preferred stocks when rates are low, increasing common stocks when the economy looks promising.

The key is not to confuse them, or you could really lose big.