What Is Preferred Stock? Basics, Benefits, and Risks

Preferred stock is an equity security that typically pays regular dividends and gives shareholders priority over common stockholders for dividend payments and claims on assets if a company is liquidated. Companies may issue preferred stock to raise capital without increasing their debt.

Preferred shareholders generally have a higher claim on assets than common shareholders if a company goes bankrupt and is liquidated. However, preferred shares usually don't provide voting rights and typically offer less potential for capital gains than common stock. As a result, investors who buy preferred stock are often seeking income rather than growth.

Preferred stock is often considered a hybrid investment with characteristics of both common stocks and bonds. Like bonds, they generally provide income and are sensitive to changes in interest rates. Like stocks, their prices can fluctuate, though they're typically less volatile than common shares.

Like bonds, preferred stock typically provides income, which may be fixed or floating based on a reference rate. Preferred stock dividends are usually paid quarterly and are a central part of the investment's return. Unlike bonds, preferred stock does not have a maturity date in most cases, meaning it can remain outstanding indefinitely after its initial issuance.

Preferred stock and bonds both provide income, but they differ in important ways.

Bonds are a form of debt. Bondholders receive interest payments and the return of principal at maturity, assuming the issuer does not default. Preferred stock, on the other hand, generally pays dividends rather than interest and usually does not have a maturity date. Preferred income payments are often discretionary, unlike a bond's interest payments. A missed interest payment by a bond would generally result in a default; that's not the case with most preferred stocks.

In a bankruptcy, bondholders are paid before preferred shareholders, which is one reason preferred stock often offers higher yields than investment‑grade bonds. Preferred stock prices are also sensitive to changes in interest rates and credit conditions, giving them characteristics of both fixed income and equity investments. Both corporate bonds and preferred stock are subject to credit risk, meaning their value depends in part on the issuer's financial strength, which is often reflected in credit ratings.

Like bonds, preferred stock also has stated "par" values. The par value of most bonds is $1,000, but the par value for most preferred stocks is $25, although some can be $50 or $100.

While both preferred stock and common stock represent equity ownership, they serve different purposes for investors:

• Common stock is typically purchased for capital appreciation and usually includes voting rights, giving shareholders a say in corporate decisions, including the election of the company's board of directors. Dividends on common stock are not guaranteed and can vary widely.
• Preferred stock, by contrast, is usually purchased for income. Preferred shareholders generally receive dividends before common shareholders and often receive higher payouts. However, preferred stockholders usually do not benefit from strong earnings growth in the same way common shareholders might, and they typically do not have voting rights.

Investors often look to preferred stock when they want income but are hesitant to rely solely on common stock or traditional bonds. For example, an investor concerned about high equity valuations may want an investment that still offers dividend income but behaves somewhat differently than common stock. Preferred stock and common stock tend to have positive correlations with each other, meaning their prices and total returns often move in the same direction, albeit by varying magnitudes.

Preferred stock can fill that gap for some investors. It allows investors to seek yield through the equity market without owning the common stock of companies that may be more volatile or growth‑dependent. While preferred stock is not risk‑free, it is often viewed as a middle ground between stocks and bonds for income‑focused portfolios. Investors can access preferred stock through individual securities or through diversified funds, such as mutual funds or ETFs.

Preferred stock generally offers higher dividend yields than common stock, which can make them appealing to income-focused investors. Dividends are typically fixed dividends or floating dividends based on a stated formula, which can provide more predictable income than common stock dividends.

Preferred shareholders have a higher claim on company earnings and assets than common shareholders. Companies generally must pay preferred dividends before paying dividends on common stock, which can provide an added layer of income priority—though dividends are not guaranteed.

Preferred stocks trade on major exchanges under ticker symbols. Because they can be bought and sold like common stocks, preferred shares may feel more accessible to investors who are less familiar with trading traditional bonds, which often trade over the counter. While preferred stocks generally trade on an exchange, liquidity can vary by issue, depending on factors like how many shares are outstanding.

Many corporate bonds are issued with a par value of $1,000, while preferred stocks are commonly issued at $25, $50, or $100 per share. This lower price point can make it easier for individual investors to access income-oriented investments and to diversify across multiple issuers.

Although preferred stocks can still experience sharp declines during periods of market stress, their prices have historically been less volatile than common stocks in more typical market conditions. Because returns are driven more by income than by earnings growth, preferred shares often fluctuate less than common equity.

Many preferred stocks pay qualified dividends that are subject to lower tax rates than traditional interest income that bonds tend to pay. Qualified dividends are generally taxed at 0%, 15%, or 20% rates, depending on income limits. Not all preferred stocks pay qualified dividends, however, so it's important to identify which securities pay dividends at those lower rates.

Although preferred stock can provide income and other potential benefits, it also carries risk. Investors should understand how factors like interest rates, call features, and market conditions may affect their value and income potential.

Preferred shareholders rank below bondholders but above common shareholders in a company's capital structure. In the event of bankruptcy or liquidation, bondholders are paid first, which helps explain why preferred stocks typically offer higher yields than a company's bonds.

While relatively uncommon, preferred stock prices can fall sharply during periods of market stress. During the 2008 financial crisis and the early 2020 pandemic selloff, broad preferred stock indexes experienced significant declines, reflecting credit concerns and reduced liquidity.

Because preferred stock is issued by a company, its value depends in part on the issuer's financial health. If the issuing company experiences financial difficulty, preferred stock prices may decline, and dividend payments could be reduced or suspended.

Preferred stocks tend to move more closely with the stock market than with high-quality government bonds. As a result, they may not provide the same downside protection that U.S. Treasuries or other highly rated bond investments often offer when equities are under pressure.

The preferred stock market is heavily weighted toward financial companies, which can increase sector-specific risk. To help manage concentration risk, investors may consider limiting exposure to any single sector within their portfolio.

Many preferred stocks are callable, meaning the issuer can redeem them at a set price—often at par—after a certain date. That means a call feature can limit how much of a preferred stock's price rises. If interest rates fall, companies may issue new preferred stocks with lower dividend rates and redeem existing ones at part. That means investors who bought above the call price could see limited upside or even a potential loss. By contrast, noncallable securities may continue to rise in price in that scenario.

Some preferred stocks trade infrequently, which can make it harder to buy or sell shares quickly. Lower trading volume may also result in wider bid/ask spreads, increasing transaction costs and potentially leading to less favorable pricing when entering or exiting a position.

Preferred stock is often considered one of the market's hybrid securities, combining characteristics of both bonds and common stock. Because preferred shareholders typically receive dividend payments before common shareholders and may have priority in liquidation, preferred stock can appeal to investors seeking income from a type of equity investment.

However, preferred stock also carries risks, including interest-rate sensitivity, call risk, and issuer credit risk. Investors considering preferred stock may want to evaluate how it fits within their broader portfolio and income strategy, potentially with guidance from a financial advisor.