Practical Guide: How to Choose Between Preferred and Common Stocks Based on Your Profile

When we start in the world of investments, an inevitable question arises: what type of common and preferred stocks best suit our objectives? The answer is not unique; it depends on your risk tolerance and your financial goals.

The reality: not all stocks are the same

Companies do not issue a single type of stock. There are at least two fundamental models, each designed to attract investors with completely different profiles. Understanding these differences is essential before investing a single peso.

The market mainly recognizes two categories: common stocks and preferred stocks. Both represent ownership in the company, but the rights associated vary significantly.

Preferred stocks: the option for conservative investors

Preferred stocks function as a hybrid between fixed income and equity. Although accounting-wise they are classified as equity on the company’s balance sheet, they behave more predictably than their counterparts.

What makes them special?

First, their dividends. Unlike ordinary shares, preferred stocks offer fixed dividend rates established in advance. This means more predictable income. If the company generates profits, you will receive your fixed percentage. If results are poor, you still have priority: you get paid before common shareholders.

In case the company faces liquidation, your investment also benefits. Preferred shareholders recover their capital before common shareholders, but after creditors and bondholders.

However, there is a trade-off: you usually do not have voting rights. You cannot participate in important corporate decisions or elect directors. Your influence over corporate management is limited.

There are sophisticated variants of preferred stocks:

• Cumulative: if the company cannot pay dividends in a period, they accumulate to be paid later
• Convertible: can be transformed into common shares under certain conditions
• Redeemable: the company can buy them back
• Participating: link dividends to actual financial performance

Common stocks: the path to growth

Common stocks are the classic vehicle for those seeking capital appreciation. They represent a purer stake in the company, with all the benefits and risks that entails.

What defines them:

First, you have decision-making power. As a common shareholder, you can vote at corporate assemblies. Your voice counts on key issues.

Second, dividends are variable and dependent on company performance. In prosperous years, they can be generous. During tough times, they may be reduced or disappear entirely. It’s a meritocratic system: better company performance, better returns for you.

Third, the potential for appreciation is considerably higher. If the company grows and prospers, the value of your shares increases. This capital growth can far surpass any dividends received.

But here’s the important part: volatility is your constant companion. Prices fluctuate based on market perception, financial reports, macroeconomic news, and factors beyond your control. This requires nerves of steel.

Within common stocks, there are also subcategories:

• Non-voting shares: participate in profits but without influence
• Multiple classes of shares: different classes with varying voting rights, allowing founders to maintain control with less ownership stake

Comparative table: side by side

The practical: how to acquire these assets

If you decide to invest in common and preferred stocks, the process is relatively straightforward:

Step 1: Choose a reliable broker
Look for regulated platforms with good reputation. Check commissions and analysis tools available.

Step 2: Open your account
Complete your personal and financial information. Make an initial deposit.

Step 3: Research before buying
Analyze company numbers, sector, and prospects. Don’t buy impulsively.

Step 4: Execute your order
Choose between “market orders” (current price) or “limit orders” (price you set).

Alternative: trading CFDs
Some brokers offer Contracts for Difference on stocks. This allows speculation without owning the actual securities. Check if your broker offers this and the available liquidity.

The winning strategy: diversification

An intelligent approach combines both types of stocks. For example:

• 60% common + 40% preferred for those seeking balance
• 80% common + 20% preferred for those tolerating more risk but wanting some stability
• 30% common + 70% preferred for those nearing retirement

Periodically review your portfolio and readjust according to changes in your personal circumstances or market conditions.

Who benefits from each type?

Common stocks: ideal for individuals in early or mid stages of their financial life, with a long time horizon (10+ years), capable of tolerating significant drops and willing to wait for recoveries. Their goal is to multiply their wealth.

Preferred stocks: perfect for those in capital preservation phase or nearing retirement, needing a regular and predictable income stream, wanting to reduce risk exposure, or seeking diversification combining benefits of fixed income and equities.

The current market context

The contrast between the S&P U.S. Preferred Stock Index (index representing approximately 71% of the preferred stock market in the United States) and the S&P 500 over the last five years perfectly illustrates these dynamics. While the S&P 500 increased by 57.60%, the preferred index fell 18.05%. This divergence reflects how these instruments respond oppositely to changes in monetary policy and interest rates.

In low-rate environments, preferred stocks become attractive. When rates rise, their appeal diminishes compared to bonds and other fixed income instruments.

Conclusion: a personal decision

There is no universal answer. Your choice between common and preferred stocks should be based on realism: your age, financial situation, goals, risk tolerance, and time horizon.

Both have a place in a well-constructed portfolio. The wise investor understands their differences, respects their limitations, and uses them strategically. Start small, learn constantly, and gradually scale your investment as you gain experience.