Investing in the stock market offers a multitude of options for wealth seekers. As common shares are what most invest in, preferred shares are often overlooked. Preferred shares represent a unique asset class that combines elements of both stocks and bonds.
Let’s dive into what preferred shares are, their advantages and disadvantages, and if they’re worth investing in!
Understanding Preferred Shares
Preferred shares, also known as preferred stocks, are a type of equity security issued by corporations. They sit between common stocks and bonds in terms of investment characteristics. When you purchase preferred shares, you are essentially buying a stake in the company, but with a few key differences from common stocks.
Typically, preferred shares are more dividends-oriented. They have higher dividend rates versus common shares. Not to mention, dividends are also more consistently given out to preferred shareholders. Due to the consistent nature of dividend payouts, preferred shares usually experience less volatility since investors already know what to expect. Price movements often occur mostly due to changes in the country’s prevailing interest rate. Lastly, they have no voting rights unlike common shares. However, it should also be noted that they usually offer options to convert the shares into ordinary ones at a later date.
Advantages of Investing in Preferred Shares
Here are some of the advantages to having preferred shares:
- Steady Income: The fixed dividend payments and lesser volatility associated with preferred shares can provide a stable and predictable income stream, making them attractive to income-oriented investors.
- Priority in Distributions: Preferred shareholders have a higher claim on company assets in the event of bankruptcy or liquidation, providing a degree of safety compared to common shareholders.
- Diversification: Including preferred shares in your portfolio can help diversify your holdings. They do so by providing yields that are consistent, adding only a small amount of risk while still providing respectable returns.
Disadvantages of Investing in Preferred Shares
Of course, preferred shares also come with some disadvantages.
- Limited Capital Appreciation: Preferred shares tend to offer limited potential for capital appreciation compared to common stocks. Even if common shares go up by a lot, preferred shares will barely move an inch.
- Interest Rate Sensitivity: They are also sensitive to changes in interest rates. When interest rates rise, the value of existing preferred shares may decline.
- Lack of Voting Rights: Preferred shareholders have no voting rights, which means they have no say in the company’s management or major decisions.
- Subordinate to Bonds: In the event of financial distress, these are safer than common shares. However, it isn’t guaranteed that no losses will be incurred. Bondholders still hold a higher priority among the list of stakeholders to be paid.
Should You Invest in Preferred Shares?
Given that some preferred shares offer high dividend yields, scouting for solid preferred shares to invest in isn’t such a bad idea. It allows you to diversify your portfolio since it has relatively low risk, while still offering a sizable reward.
As always, conduct thorough research first before choosing one to invest in. Make sure to consider your overall investment strategy as well so that your decisions align with your goals!
