The Difference Between Preferred and Common Stock
Published Sat, May 16, 2020 at 11:28 AM PST
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By Obioha Okereke
Generally, when you go to purchase stock, you’ll be buying shares of common stock. What does this mean?
When investing, people typically invest in two types of stock: common or preferred. When you go to purchase a share of a company through a bank, or through an app, you’re likely purchasing shares of common stock.
What is common stock?
In simple terms, common stock is stock that represents ownership of a company. Common stock carries more risk than preferred stock because if a company goes bankrupt, creditors and preferred stock holders are paid before common stock holders.
When you own common stock, you have the ability to vote on the board of directors, and other corporate issues within a company. The more shares you own, the more voting power you have! In most cases, one share of common stock will be the equivalent to one vote.
To better understand common stock, imagine you opened up a brokerage account and purchased 100 shares of Amazon stock. You would now own 100 shares of Amazon common stock. For every share of common stock, you are entitled to one vote for the board of directors, and one vote for new proposals.
That’s cool, but what about Preferred Stock?
Owners of preferred stock have a greater claim to any dividends or assets (in the event of bankruptcy) than common stockholders. What this means is that, preferred shareholders will receive their dividend payments first. In the case of liquidation, they will receive priority when it comes to being reimbursed.
Preferred stockholders do not have the same rights as common stockholders and generally do not get voting rights.
The most important takeaway from this is that when you purchase stock, you purchase ownership of a company. When buying preferred stock, you take on less risk and are entitled to receive your investment in full if a company goes bankrupt. With common stock, it is possible that in the event of bankruptcy, you won’t receive anything at all.
Learn more: The Difference Between Preferred and Common Stock
Dividends
In some cases, a company may pay dividends. A dividend is a small distribution of a company’s earnings to their stockholders. Investors in a company that pays dividends will receive dividends for every share that they own. It is important to note that dividend payments typically occur on a monthly, quarterly, semi-annual, or annual basis.
Dividends are usually paid in cash! You can select whether or not you want to receive dividends to your brokerage account, or if you’d like to reinvest all dividends. If you’d like to truly take advantage of compounding, and grow your investments, you should look into reinvesting your dividends. Reinvesting dividends allows you to take the money you receive from a company and use it to purchase more stock.
Let’s walk through a scenario.
Assume that you own 47 shares of Microsoft. Microsoft pays a quarterly dividend of $0.51 per share, so, you’ll receive $2.04 per share (quarterly dividends are paid 4 times a year). This means…on Microsoft alone, you will make $95.88 a year off dividends. This is on top of anything you earn from the stock price increasing. So, by reinvesting dividends, you’ll be purchasing an additional 1/2 share every year. This is a great way to automate your investing and grow your portfolio.
YOU STILL PAY TAXES ON DIVIDENDS. Qualified dividends are regarded as income and thus, they are taxed as such.
If the process of reinvesting dividends is still confusing, check out this article: Why You Should Always Reinvest Your Dividends
Wondering how you can avoid paying taxes on dividends?
Open up a Roth IRA! A Roth IRA is retirement account that allows for investors to take advantage of tax-free growth. The money you make in a ROTH IRA is not taxed. Let me repeat myself to make sure you understand, the money you invest in a Roth IRA is tax-free. There is a catch though – you can’t withdraw money from a Roth IRA until you’re 59 ½ years old. There are a few exceptions to this rule but this is something you need to know when investing using a Roth IRA.
Read More: What is a Roth IRA?
