Preferred stocks can feel like the “mystery middle child” of the investing world—not quite a stock, not quite a bond, but somehow a blend of both. And if you’ve ever wondered whether they actually belong in your portfolio, you’re not alone.
Many women I coach want steady income without taking on wild stock market swings, and preferreds can offer exactly that… if you understand how they work.
In this article, we’ll break down preferred stocks in plain, jargon-free English—what they are, how they pay, the risks you need to watch out for, and how to know if they’re a smart choice for your retirement strategy. Let’s make this simple, clear, and totally confidence-boosting.
Table of Contents
What Are Preferred Stocks?
Preferred stocks sit in a unique middle ground between regular stocks and bonds, giving us ownership in a company while providing more predictable income than common shares. They don’t usually come with voting rights, but they offer priority when companies pay dividends and distribute assets.
Understanding the Basics
Preferred stock represents a class of ownership that gives us a stake in a company, but it works differently than the common stock most of us know. When we buy preferred shares, we’re essentially getting a hybrid investment that acts part stock, part bond.
The “preferred” part of the name isn’t just for show. We get preference over common stockholders when the company pays dividends. If a company runs into financial trouble and needs to liquidate, we also stand in line ahead of common shareholders to get our money back.
Most preferred stocks pay fixed dividends at regular intervals, usually quarterly. These payments stay the same regardless of how well the company performs, which makes them attractive if we’re looking for steady income. The catch? We typically give up voting rights that common stockholders enjoy.
Key features we should know:
- Fixed dividend payments that don’t change
- Priority claim on company assets
- No voting rights in most cases
- Trade on exchanges like regular stocks
Preferred vs. Common Stocks
The difference between preferred and common stock comes down to priority and predictability versus growth potential and control. Common stocks give us voting rights and the chance to benefit from big price increases when companies succeed. Preferred stocks trade those perks for more reliable income.
Common shares are abundant and trade constantly throughout the day. Preferred shares exist in much shorter supply, which affects how easily we can buy and sell them.
When dividends get paid, we get ours first as preferred shareholders. Common stockholders only receive dividends after we’ve been paid. If the company skips dividend payments, many preferred stocks are cumulative, meaning we’ll get all those missed payments before common shareholders see a penny.
The downside? Our preferred shares won’t soar in value the way common stock might when a company takes off. We’re choosing stability over the lottery ticket potential that attracts many investors to common stocks.
Preferred Stocks vs. Bonds
Preferred stocks share similarities with bonds that make them appealing fixed-income investments, but they’re not identical twins. Bonds are loans we make to companies or governments that must be repaid. Preferred stocks are ownership stakes, even if they act more like bonds than typical stocks.
Both pay us regular income, but bonds pay interest while preferred stocks pay dividends. This matters come tax time, since dividend income often gets taxed at lower rates than interest income.
Here’s how they stack up:
| Feature | Preferred Stocks | Bonds |
|---|---|---|
| Payment type | Dividends | Interest |
| Payment guarantee | Not guaranteed | Contractual obligation |
| Maturity date | Usually none | Fixed end date |
| Claim on assets | After bondholders | Before stockholders |
If a company goes bankrupt, bondholders get paid before we do as preferred shareholders. That extra risk is why preferred stocks typically offer higher yields than bonds from the same company. We’re taking on more risk, so we expect more reward.
Unlike bonds that mature and return our principal, most preferred stocks don’t have maturity dates. We can hold them indefinitely as long as the company keeps paying dividends, or we can sell them on the exchange whenever we need our money back.
Types of Preferred Stocks
Preferred stocks come in different varieties, each with unique features that affect how you get paid and what happens if the company misses dividend payments. The main types include cumulative stocks that track unpaid dividends, non-cumulative stocks that don’t owe you missed payments, convertible stocks that can become common shares, and participating stocks that let you earn extra dividends beyond your fixed rate.
Cumulative Preferred Stocks
We think cumulative preferred stocks are the safest bet for investors who worry about missing payments. These shares keep track of every dividend the company skips or can’t pay.
When a company faces tough times and cuts dividends, cumulative preferred stock builds up a running tab of what they owe you. Before the company can pay common stockholders a single penny in dividends, they must pay us all the back dividends first.
Let’s say a company owes $5 per share in annual dividends but skips three years of payments. That’s $15 per share they owe us before anyone else gets paid. This protection matters because we don’t lose our dividend rights just because the company had a bad year.
The cumulative feature acts like insurance for our income stream. Companies can’t just forget about missed payments and move on.
Non-Cumulative Preferred Stocks
Non-cumulative preferred stocks work differently and carry more risk for us as investors. If the company skips a dividend payment, that money is gone forever.
We don’t get to collect those missed payments later, even if the company returns to profitability. The slate gets wiped clean each quarter or year. This means we could lose significant income if the company struggles for several years.
Why would anyone buy these? They usually pay higher dividend rates to make up for the extra risk. Companies like offering non-cumulative preferred shares because they don’t have to worry about piling up debt to shareholders.
We need to carefully check the company’s financial health before investing in non-cumulative preferreds. A stable, profitable company with consistent earnings poses less risk of skipping payments. But if you’re looking at a company with shaky finances, the lack of cumulative protection could hurt your returns.
Convertible Preferred Stocks
Convertible preferred stocks give us the best of both worlds. We get steady dividend payments like regular preferred stock, but we can also swap our shares for common stock if we want.
This conversion feature lets us participate in the company’s growth. If the common stock price shoots up, we can convert our preferred shares and sell them at the higher price. The conversion ratio tells us exactly how many common shares we get for each preferred share.
Think of it like having an option to join the party if things get exciting. We collect our reliable dividends while we wait, and if the stock takes off, we can convert and ride the wave up. Convertible preferred stocks typically pay lower dividend rates than regular preferreds because this conversion feature has value.
The conversion price is usually set above the current common stock price when the preferred shares are issued. We only convert when it makes financial sense, which happens when the common stock price rises above our conversion value.
Participating Preferred Stocks
Participating preferred stocks let us earn more than our fixed dividend rate. After we receive our regular dividend and common stockholders get theirs, we get to participate in additional dividend distributions.
We essentially get paid twice. First, we collect our guaranteed preferred dividend. Then, if there’s extra profit to distribute, we share in those extra dividends alongside common shareholders.
Participating preferred shares are rare because companies don’t love giving away extra profits. But when we find them, they offer excellent upside potential while maintaining the safety of preferred stock. Some participating preferreds have caps that limit how much extra we can earn, while others are fully participating with no upper limit.
The math works like this: if our preferred dividend is $3 per share and common stock gets $2, we collect our $3 first. If the company then pays an extra $1 per share to common stockholders, we also get that extra $1. Our total dividend becomes $4 per share instead of just $3.
Key Features and Characteristics
Preferred stocks come with three main features that set them apart from common stocks: they pay regular dividends that act like interest payments, companies can buy them back at specific times, and shareholders typically can’t vote on company decisions.
Dividend Payments
We need to talk about what makes preferred stock dividends special. Unlike common stock dividends that change based on company performance, preferred stocks typically pay fixed dividends on a regular schedule. Think of it like getting a paycheck that arrives at the same time every period.
Types of dividend features include:
- Fixed-rate dividends: You receive the same payment amount each period
- Cumulative dividends: Missed payments pile up and must be paid before common stockholders get anything
- Non-cumulative dividends: If the company skips a payment, you lose it forever
- Participating dividends: You can earn extra dividends beyond your fixed rate if the company does really well
The cumulative feature offers us protection when companies face tough times. If a company misses three quarterly payments, they owe us all that money before common shareholders see a penny.
Callability and Redemption
Here’s something that catches many investors off guard: companies can buy back their preferred shares when it suits them. This callability feature means the company sets a date and price where they can redeem our shares.
Companies usually call their preferred stock when interest rates drop. They redeem the old shares paying 7% and issue new ones at 4%. That’s great for them but leaves us scrambling to reinvest our money at lower rates.
Most preferred stocks have a call price slightly above the original price. A $25 share might be callable at $26 after five years.
Voting Rights (Or Lack Thereof)
Let’s be honest: when we buy preferred stock, we’re giving up our voice in company decisions. Preferred shareholders typically cannot vote on board members or major business changes. That’s the trade-off for getting those steady dividend payments.
Some preferred stocks grant us voting rights only in specific situations. If the company misses several dividend payments, we might gain the right to vote on board seats. It’s like an emergency clause that activates when things go wrong.
How Preferred Stocks Work in the Real World
When we move beyond theory and look at actual preferred stock investments, we see specific payment schedules, real companies issuing these securities, and investors managing their portfolios with them. The day-to-day operation of preferred stocks involves regular dividend payments, varies significantly across different companies, and creates unique experiences for income-focused investors.
Dividend Payment Schedules
Most preferred stocks pay dividends on a quarterly basis, though some pay monthly or annually. We typically see companies announce dividend payment dates about 30 days in advance, with the actual payment arriving in our brokerage accounts on the specified date.
Cumulative vs. Non-Cumulative Payments:
- Cumulative preferred stocks require companies to pay all missed dividends before common stockholders receive anything
- Non-cumulative preferred stocks let companies skip payments without owing us back payments later
The dividend rate is usually fixed when the stock is issued. For example, a $25 preferred stock with a 6% rate pays us $1.50 per share annually, or $0.375 per quarter. Some preferred securities offer more predictable income than common stocks, which makes tracking these payment schedules easier for our planning.
Real-Life Company Examples
Major banks and financial institutions are the biggest issuers of preferred stocks. Bank of America, Wells Fargo, and JPMorgan Chase all have multiple preferred stock series trading on exchanges right now.
Utilities also love issuing preferreds. Companies like Duke Energy and Southern Company offer preferred shares that trade on exchanges alongside their common stock. These utility preferreds typically yield between 4% and 6%, making them attractive for income investors.
Real estate investment trusts (REITs) frequently use preferred stocks too. Public Storage and Digital Realty Trust have issued several series of preferreds. These securities help companies raise capital without diluting common shareholders or taking on traditional debt.
Investor Experiences
Income investors often include preferreds in portfolios seeking steady cash flow. We might allocate 10-20% of a fixed-income portfolio to preferreds, balancing them with bonds and dividend-paying common stocks.
The challenge comes during market volatility. When interest rates rise, preferred stock prices typically fall, just like bonds. We saw this in 2022 when many preferreds dropped 15-20% as the Federal Reserve raised rates aggressively.
Tax treatment matters for our returns. Qualified dividend income from preferreds gets taxed at lower capital gains rates rather than ordinary income rates. This tax advantage makes preferreds more appealing than bonds paying similar yields, especially for investors in higher tax brackets.
Risks and Rewards of Investing in Preferred Stocks
Preferred stocks carry unique risks that we need to understand before investing our money. Interest rate changes affect preferred stock prices, companies can fail to pay dividends, and selling shares quickly isn’t always easy.
Interest Rate Sensitivity
When interest rates rise, preferred stock prices typically fall. This happens because preferred stocks pay fixed dividends, so when new investments offer higher rates, our existing preferred shares become less attractive to other buyers.
Think of it like owning a car that suddenly becomes less valuable when a better model hits the market. If we bought preferred stock paying 5% and rates jump to 7%, we’re stuck earning less than we could with newer investments. The price of our shares drops to reflect this difference.
Rate changes impact us in two ways:
- Paper losses – Our shares lose value even though we still receive dividends
- Opportunity cost – We miss out on higher-paying investments elsewhere
We can protect ourselves by buying preferred stocks when rates are high or choosing shorter-duration preferred shares that adjust more quickly to rate changes.
Default and Credit Risk
Companies can run into trouble and stop paying dividends on preferred stocks. Unlike bond payments, preferred stock dividends aren’t guaranteed, and companies can skip them without going bankrupt.
We face real danger if the company fails completely. Preferred shareholders get paid before common stockholders during bankruptcy, but only after bondholders take their share. Many times, nothing remains for us.
Credit ratings help us judge this risk. We should check ratings from agencies like Moody’s or Standard & Poor’s before buying. Lower-rated preferred stocks pay higher dividends to compensate for increased risk, but that extra income won’t matter if the company defaults.
Liquidity Challenges
Selling preferred stocks quickly can be harder than selling common stocks. Many preferred shares trade less frequently, meaning fewer buyers exist when we want to sell.
This creates a problem during emergencies. If we need cash fast, we might have to accept a lower price than our shares are worth. The limited trading activity of preferred stocks means the difference between buying and selling prices (the spread) is often wider than with common stocks.
Watch for these red flags:
- Daily trading volume under 10,000 shares
- Wide bid-ask spreads exceeding 1%
- Few market makers supporting the stock
We recommend keeping preferred stocks as long-term investments and maintaining an emergency fund in more liquid assets for unexpected expenses.
Comparing Preferred Stocks to Other Investment Options
When we’re building our investment portfolios, we need to understand how preferred stocks stack up against bonds, common stocks, and other fixed income options. These hybrid securities combine features of stocks and bonds, offering us a middle ground that can solve specific portfolio challenges.
Fixed Income Alternatives
Let’s talk about how preferred stocks compare to our traditional fixed income choices. When we look at corporate bonds, they typically offer lower yields than preferred stocks but come with greater security in bankruptcy situations. Bondholders get paid before preferred shareholders if a company goes under.
Key Differences:
- Yield: Preferred stocks usually pay higher dividends than bonds from the same company
- Tax Treatment: Qualified dividends from preferreds may get better tax treatment than bond interest
- Risk Level: Bonds have priority in bankruptcy, making them safer
- Price Volatility: Preferreds tend to be more volatile than bonds but less than common stocks
We should also compare preferreds to other options like REITs and dividend-paying common stocks. Preferred stocks share characteristics of both debt and equity, which means they react differently to interest rate changes than pure bonds. When rates rise, preferred stock prices typically fall, just like bonds do.
The reality is that preferred stocks give us higher income potential than most bonds while offering more stability than common stocks.
How Preferred Stocks Fit in a Portfolio
We can use preferred stocks to fill a specific gap in our investment strategy. They work best when we need steady income but want more yield than bonds provide. Think of them as the middle child in our portfolio—not as exciting as growth stocks, but more reliable than hoping for capital appreciation alone.
Portfolio Allocation Considerations:
- Income Focus: 10-20% allocation for retirees seeking steady cash flow
- Balanced Approach: 5-10% as a diversification tool
- Growth Focus: 0-5% or skip entirely if capital appreciation is the priority
Preferred shares have attributes of both stocks and bonds, making them useful for income investors who’ve maxed out their bond allocations but still want relatively stable returns. We shouldn’t treat them as our core holdings, though. They lack the growth potential of common stocks and the safety of government bonds.
The sweet spot? We can use preferreds to boost our portfolio’s income without taking on the full volatility of common stocks. They’re particularly useful when we’re transitioning from aggressive growth to income generation as we approach retirement.
Evaluating and Selecting Preferred Stocks
When we’re picking preferred stocks, we need to focus on two main factors: the company’s financial strength and its track record of paying dividends. These elements tell us whether we can count on those steady dividend payments we’re after.
Analyzing Credit Ratings
Credit ratings are like report cards for companies, and they matter a lot when we’re choosing preferred stocks. Agencies like Moody’s, Standard & Poor’s, and Fitch grade companies based on their ability to pay their debts and dividends.
Investment-grade ratings (BBB- or higher) mean the company is financially stable. Non-investment grade (below BBB-) signals higher risk. We want to aim for companies with ratings of BBB or higher when we’re starting out.
Here’s what the ratings mean:
- AAA to AA: Extremely strong ability to pay
- A to BBB: Good to adequate payment ability
- BB and below: Speculative with higher risk
Companies with lower ratings usually offer higher dividend yields to attract investors. That sounds tempting, but here’s the catch: those higher yields come with a greater chance the company might skip dividend payments or even default. We need to balance our desire for income with our comfort level for risk.
Understanding Dividend History
A company’s past dividend payments show us what we might expect in the future. We should look at whether the company has paid dividends consistently over the past 5 to 10 years.
Preferred stocks typically offer fixed dividends, but some companies have cumulative features. This means if they miss a payment, they owe it to us later before common stockholders get anything. That’s a safety feature we really appreciate.
Check these key points in dividend history:
- Payment consistency: Has the company paid every quarter without fail?
- Suspension history: Did they ever stop paying, and why?
- Recovery time: If they stopped, how long did it take to resume?
Companies that maintained dividend payments even during tough economic times show real commitment to preferred shareholders. We can feel more confident investing in these businesses because they’ve proven they prioritize our income stream.
How to Buy and Sell Preferred Stocks
We know the process of buying preferred stock can feel confusing at first. The good news? It’s actually pretty similar to buying regular stocks.
We need to start with a brokerage account. Most online brokers let us trade preferred stocks just like common shares. We can use platforms like Fidelity, Charles Schwab, or TD Ameritrade to get started.
Here’s what we need to do:
- Open a brokerage account if we don’t have one
- Search for the preferred stock ticker symbol (usually ends in -P or .PR)
- Review the dividend rate and terms
- Place our buy order
- Monitor our investment regularly
When we’re ready to purchase preferred shares, we’ll notice they trade on major exchanges. We simply enter the ticker symbol and choose how many shares we want.
Selling works the same way. We log into our brokerage account, find our preferred stock holdings, and place a sell order. Easy enough, right?
Important things to remember:
- Preferred stocks may have lower trading volume than common stocks
- This can mean wider bid-ask spreads
- We might need to be patient when buying or selling
- Some preferred stocks are callable, meaning the company can buy them back
The process of purchasing preferred stocks carries more risk than bonds but offers potentially higher payouts. We get regular fixed dividend payments, which is one reason many of us find them attractive.
Just remember to check the specific terms before we buy. Each preferred stock has different features.
Tax Considerations with Preferred Stocks
When we invest in preferred stocks, we need to understand how taxes affect our returns. The good news is that preferred stock dividends often qualify for special tax treatment, which can help us keep more money in our pockets.
Qualified Dividend Income (QDI)
Many preferred stock dividends count as qualified dividends. This matters because qualified dividends are taxed at lower rates than regular income. Instead of paying our normal income tax rate, we pay the dividend tax rate.
The tax rates for qualified dividends work like this:
- 0% for lower income brackets
- 15% for middle income brackets
- 20% for the highest income earners
These rates are much better than ordinary income tax rates, which can go up to 37%. The qualified dividend tax treatment can provide attractive after-tax yields compared to fully taxable bonds.
Important Requirements
We can’t just buy preferred stock and automatically get these lower tax rates. There are holding period requirements we must meet for our dividends to qualify. We typically need to hold the preferred stock for a minimum period around the dividend payment date.
Understanding these tax implications helps us make smarter investment choices and maximize our returns after taxes.
Common Pitfalls and How to Avoid Them
We’ve all been there—lured by those attractive dividend yields only to discover preferred stocks come with their own set of traps. Let’s walk through the common pitfalls investors face so we don’t learn these lessons the hard way.
Interest Rate Risk is our first major challenge. When interest rates rise, preferred stock prices typically fall. We need to remember that preferreds behave more like bonds than common stocks in this regard. The solution? Avoid loading up on preferreds when rates are at historic lows.
Call Risk catches many of us off guard. Companies can redeem their preferred shares when it suits them, usually when rates drop. We might buy a preferred stock yielding 7%, only to have it called away when similar investments yield just 4%. Always check the call date and call price before investing.
Here are the key mistakes we should avoid:
- Ignoring credit ratings – Lower-rated preferreds offer higher yields but carry more default risk
- Chasing yield blindly – An unusually high yield often signals underlying problems
- Forgetting about liquidity – Some preferreds trade infrequently, making them hard to sell quickly
- Overlooking cumulative vs. non-cumulative dividends – Non-cumulative preferreds don’t make up missed payments
Tax treatment is another area where we need to pay attention. Not all preferred dividends qualify for favorable tax rates. We should verify the tax status before assuming we’ll get the qualified dividend rate.
The bottom line? We need to read the prospectus and understand what we’re buying. Yes, it’s boring, but it beats discovering unpleasant surprises after we’ve invested our money.
Who Should Consider Investing in Preferred Stocks?
We know you’re wondering if preferred stocks are right for your portfolio. Let’s break down who benefits most from these investments.
Income-focused investors should pay attention here. Preferred stocks often offer high yields and provide steady dividend payments that arrive like clockwork. If you’re looking for regular cash flow, these securities might be calling your name.
Retirees make up a key group of preferred stock investors. When you’re living off your investments, preferred stocks can be appealing for passive income. The predictable payments help cover monthly expenses without touching your principal.
Conservative investors who want something between bonds and common stocks often find their sweet spot here. We’re talking about people who can handle some risk but don’t want the wild swings of regular stocks.
Here’s who typically invests in preferred stocks:
- Retirees seeking steady income
- Income investors who prioritize dividends over growth
- Conservative investors wanting less volatility than common stocks
- Portfolio diversifiers looking to balance their holdings
That said, preferred stocks aren’t for everyone. If you’re young and focused on long-term growth, common stocks usually offer better returns. We also wouldn’t recommend them if you need quick access to your money, since preferred stocks blend equity and debt characteristics and can be less liquid than regular stocks.
Think about your financial goals before jumping in.
The Final Takeaway
Preferred stocks aren’t for everyone, but they can offer steady income and stability when you understand what you’re buying. The key is knowing how they fit into your bigger financial picture—so you’re not just chasing yield, but building long-term security.
Want help creating a retirement plan that combines income, growth, and peace of mind? Watch our $80,000/year (tax-free) retirement case study and get your personalized retirement plan. Because when you invest with clarity instead of confusion, your money becomes a powerful source of freedom.
