Learn how preferred stock dividends compare with common stock dividends and whether beginners should choose common or preferred stocks for income.
Dividend investors often start with a simple question:
Should I buy common stock or preferred stock for dividend income as a beginner?
Both can provide income, but they work differently.
Common stock is what most people think of when they hear the word “stocks.” Common shareholders generally participate in the company's growth, may receive dividends, and typically have voting rights.
Preferred stock is a different type of equity security. It generally has a higher claim on dividends than common stock and usually has a liquidation preference over common shares. In exchange, preferred shareholders typically have less participation in the company's upside and often have limited or no voting rights.
For an investor primarily interested in income, preferred stock dividends can appear attractive because preferred shares often have relatively predictable dividend payments.
But predictability does not mean risk-free.
Preferred shares have their own risks, including interest-rate sensitivity, call risk, credit risk, and the possibility that dividends can be suspended depending on the security's terms.
For beginners, the better choice therefore depends on the investor's objective.
If the goal is long-term wealth creation and dividend growth, common stocks may offer greater potential.
If the primary objective is a potentially more predictable stream of income and the investor understands the unique risks of preferred securities, preferred stock may deserve consideration.
Understanding the difference is essential before choosing either one.
What Is Common Stock?
Common stock represents an ownership interest in a company.
When you purchase common shares, you generally become a partial owner of the business.
Common shareholders may benefit from:
- Dividend payments
- Share-price appreciation
- Dividend growth
- Voting rights
- Participation in the company's long-term growth
However, dividends on common stock are generally not guaranteed.
A company's board of directors can increase, reduce, suspend, or eliminate a common-stock dividend depending on the company's financial condition and dividend policy.
This makes common stock different from a fixed-income investment.
Example of Common Stock Dividends
Suppose you purchase 100 shares of a company paying an annual dividend of $2 per share.
Your annual dividend income would be:
100 × $2 = $200
If the company increases its dividend to $2.20:
100 × $2.20 = $220
Your income increased without buying additional shares.
That potential for dividend growth is one of the major attractions of common stocks for long-term dividend investors.
What Is Preferred Stock?
Preferred stock is a class of equity that generally has characteristics of both common equity and fixed-income securities.
Preferred shareholders generally have a higher priority than common shareholders when it comes to dividends and liquidation proceeds, although they remain behind creditors and other senior obligations.
Preferred shares commonly have features such as:
- Stated dividend rates
- Dividend preference over common shares
- Liquidation preference
- Limited voting rights
- Call provisions
- Convertible features on some issues
- Cumulative or non-cumulative dividends depending on the security
The exact terms matter.
Not all preferred stocks are structured the same way.
Therefore, investors should read the specific security's prospectus and offering documents rather than assuming every preferred share works identically.
Common Stock vs. Preferred Stock at a Glance
| Feature | Common Stock | Preferred Stock |
|---|---|---|
| Ownership | Yes | Yes, but with different rights |
| Dividend | Usually variable | Often fixed or formula-based |
| Dividend priority | Lower | Higher than common |
| Voting rights | Usually available | Often limited or absent |
| Growth potential | Generally higher | Generally more limited |
| Dividend growth | Possible | Often limited |
| Liquidation priority | Behind preferred | Ahead of common, behind creditors |
| Interest-rate sensitivity | Varies | Often significant |
| Call risk | Generally not applicable in the same way | Can be significant |
| Income predictability | Lower | Often higher |
| Complexity | Generally simpler | Generally more complex |
The table is a general comparison. Individual securities can have different terms.
How Preferred Stock Dividends Work
Preferred stock dividends are usually specified as a fixed dollar amount or percentage of the preferred stock's liquidation preference.
For example, suppose a preferred share has:
$25 liquidation preference
6% annual dividend rate
The annual dividend would generally be:
$25 × 6% = $1.50 per share
An investor holding 1,000 shares would receive:
1,000 × $1.50 = $1,500 per year
assuming the dividend is declared and payable under the security's terms.
This can make preferred shares attractive to investors who prioritize income predictability.
However, investors should not assume that a stated preferred dividend is equivalent to a guaranteed payment.
The company's financial condition and the security's specific terms matter.
Cumulative vs. Non-Cumulative Preferred Dividends
One of the most important distinctions beginners should understand is whether preferred dividends are cumulative or non-cumulative.
Cumulative Preferred Stock
With cumulative preferred stock, unpaid dividends generally accumulate.
Suppose a company has cumulative preferred shares paying $1.50 per share annually.
If the company suspends the preferred dividend for one year, the unpaid amount generally accumulates.
If the dividend is later resumed, accumulated dividends generally must be paid before common shareholders receive dividends.
The precise legal terms of the security determine how this works.
Non-Cumulative Preferred Stock
With non-cumulative preferred stock, skipped dividends generally do not accumulate in the same way.
If the company does not pay a dividend, the investor may permanently lose that missed payment.
This distinction can be particularly important when comparing preferred securities.
Why It Matters
Two preferred stocks can have similar yields but very different risk characteristics.
Before purchasing preferred stock, examine:
- Whether dividends are cumulative
- The dividend rate
- Call provisions
- Maturity or redemption terms
- Conversion features
- Credit quality
- Seniority
- The issuing company's financial condition
Which Has Better Dividend Growth?
For long-term dividend-growth investors, common stock generally has an important advantage.
A company can increase its common-stock dividend as earnings and cash flow grow.
For example:
| Year | Common Dividend |
|---|---|
| 1 | $1.00 |
| 2 | $1.08 |
| 3 | $1.17 |
| 4 | $1.26 |
| 5 | $1.36 |
The investor's income can grow over time.
Preferred stock often has a stated dividend that remains unchanged unless the security has a variable or adjustable-rate structure.
For example:
6% preferred dividend → 6% preferred dividend → 6% preferred dividend
The income may be more predictable, but it may not grow at the same rate as a successful company's common-stock dividend.
This creates an important trade-off:
Preferred stock: potentially more predictable income.
Common stock: potentially greater dividend-growth and capital-appreciation potential.
Which Has More Capital-Growth Potential?
Common stock generally provides greater participation in the company's long-term growth.
Imagine a company that grows substantially over 10 or 20 years.
Common shareholders can potentially benefit from:
- Higher earnings
- Higher dividends
- Dividend increases
- Share-price appreciation
Preferred shareholders may receive their stated dividend while having much less participation in the company's upside.
This is because preferred stock is generally designed with different economic rights.
Therefore, a beginner seeking long-term total return may find common stock more appropriate than preferred stock in many circumstances.
But a retiree or income-focused investor may place a different value on predictable distributions.
Which Has Higher Dividend Priority?
Preferred shareholders generally have priority over common shareholders when it comes to dividends.
A simplified structure looks like this:
Creditors → Preferred shareholders → Common shareholders
This does not mean preferred dividends are guaranteed.
It means that when dividends are being distributed, preferred shareholders generally have contractual or legal priority over common shareholders according to the security's terms.
This distinction becomes particularly important if a company experiences financial difficulty.
If the company cannot pay its common dividend, the common dividend can generally be reduced or eliminated.
Preferred shareholders may have additional protections depending on the issue.
However, if the company is in severe financial distress, preferred shareholders can also face substantial losses.
Preferred Stock Is Not the Same as a Bond
Beginners sometimes assume that preferred stock is essentially a bond.
It is not.
Both can provide relatively predictable income, but they occupy different positions in a company's capital structure.
Generally:
Bonds and other debt → Preferred equity → Common equity
Debt holders generally have priority over preferred and common shareholders.
Preferred shareholders have priority over common shareholders but remain equity investors.
This distinction matters because preferred stock can lose significant value if the issuing company's financial condition deteriorates.
Interest Rates and Preferred Stock
Interest rates are particularly important for many preferred stocks.
Why?
Because many preferred shares pay a relatively fixed dividend.
Suppose a preferred share pays $1.50 annually and trades at $25.
Its current yield is:
$1.50 ÷ $25 = 6%
Now imagine newly issued comparable securities begin offering significantly higher yields because market interest rates have increased.
Investors may demand a lower price for the existing preferred share to compensate for its less attractive fixed payment.
This can cause the market price of the preferred stock to decline.
Therefore, investors purchasing preferred stock should understand that:
A stable dividend payment does not necessarily mean a stable market price.
An investor can continue receiving the stated dividend while the market value of the preferred shares falls.
Call Risk: An Important Preferred Stock Risk
Many preferred stocks are callable.
A callable security gives the issuer the right to redeem the shares under specified conditions, usually at a predetermined price after a certain date.
This creates call risk.
Imagine you purchase a preferred share for $25 that pays a 7% dividend.
If the company can redeem it at $25 and market conditions allow the company to issue new preferred shares at a lower rate, the company may have an incentive to call the existing issue.
The investor may receive the redemption value but lose the opportunity to continue earning the higher dividend.
This is one reason investors should never evaluate preferred shares based solely on their current yield.
Common Stock vs. Preferred Stock: Which Is Safer?
There is no universal answer.
Preferred stock generally has greater priority than common stock, which can provide an additional layer of protection.
But preferred shares have their own risks.
For example:
- Preferred dividends may be suspended depending on the security's terms.
- Market prices can decline.
- Interest-rate increases can pressure prices.
- Callable securities can be redeemed.
- Issuer credit deterioration can hurt the investment.
- Inflation can reduce the purchasing power of fixed distributions.
- Some preferred securities can be difficult to trade.
Common stocks have different risks:
- Dividends can be cut.
- Share prices can be highly volatile.
- Businesses can fail.
- Earnings can decline.
- Investors can lose substantial capital.
Therefore, preferred stock should not automatically be labeled “safe.”
It is better understood as a different risk-and-return structure.
Should Beginners Buy Common Stock or Preferred Stock for Dividend Income?
For many beginners building their first long-term dividend portfolio, common stock may be easier to understand and manage.
Why?
Common stocks generally provide:
- Simpler ownership structures
- Greater dividend-growth potential
- Greater participation in company growth
- Potential capital appreciation
- Easier access to company financial information
- Broad availability across industries
Preferred stocks may make more sense for investors who specifically understand and want their characteristics.
These can include investors seeking:
- Higher current income
- Greater dividend priority than common shareholders
- Exposure to a particular preferred security
- Potentially less participation in common-stock upside in exchange for income characteristics
The key is not that one is universally superior.
The key is matching the security to the investor's objective.
A Simple Example for Beginners
Imagine you have $10,000 to invest.
Option A: Common Stock
Suppose the stock has:
- 3% dividend yield
- Potential dividend growth
- Potential capital appreciation
Initial annual dividend:
$10,000 × 3% = $300
If the dividend grows over time, your annual income can potentially increase.
Option B: Preferred Stock
Suppose the preferred stock has:
- 6% current yield
- Limited dividend growth
- Greater interest-rate sensitivity
- Possible call provisions
Initial annual income:
$10,000 × 6% = $600
At first glance, the preferred stock appears better.
But the comparison is incomplete.
The common stock may increase its dividend and share price over many years.
The preferred stock may continue paying approximately the same distribution while its market price fluctuates with interest rates and credit conditions.
This is why the highest current yield is not necessarily the best long-term choice.
When Common Stock May Be More Appropriate
Common stock may be more suitable when an investor prioritizes:
Long-Term Wealth Building
Investors seeking growth over decades may value participation in business expansion.
Dividend Growth
Companies with sustainable dividend-growth policies can potentially increase income over time.
Inflation Protection
Dividend growth can potentially help income keep pace with inflation, although it is never guaranteed.
Capital Appreciation
Common shareholders generally have more direct participation in the company's growth.
Simplicity
Common stocks are generally easier for beginners to understand than securities with complex preferred-share terms.
When Preferred Stock May Be Worth Considering
Preferred stock may be worth considering when an investor prioritizes:
Current Income
Preferred shares often have relatively high stated dividend rates.
Dividend Priority
Preferred shareholders generally have priority over common shareholders for dividends.
Reduced Participation in Common-Stock Upside
Some investors may accept less upside in exchange for income characteristics.
Portfolio Income Diversification
Preferred securities can provide another source of equity income alongside common stocks, bonds, REITs, and other investments.
However, preferred securities should be researched individually.
Checklist in Evaluating Preferred Stock Dividends
Before purchasing a preferred stock, examine more than the yield.
1. Dividend Rate
Determine the stated dividend and how it is calculated.
2. Current Yield
Compare the annual dividend with the price you would pay.
3. Cumulative or Non-Cumulative
Understand what happens if dividends are suspended.
4. Call Date and Call Price
Determine whether the issuer can redeem the security and under what conditions.
5. Credit Quality
Research the financial condition of the issuing company.
6. Interest-Rate Exposure
Understand how changes in market interest rates could affect the preferred stock's market price.
7. Conversion Rights
Some preferred securities can be converted into common shares under specified conditions.
8. Liquidation Preference
Understand the amount and priority specified in the security's terms.
9. Trading Liquidity
Some preferred shares trade less actively than common stocks.
A wide bid-ask spread can increase transaction costs.
10. Tax Treatment
Dividend taxation can vary depending on the type of preferred security, issuer, investor, account, and jurisdiction.
U.S. and Canadian investors should verify the applicable tax rules rather than assuming all preferred dividends receive identical tax treatment.
7 Common Mistakes Beginners Make With Preferred Stocks
Mistake 1: Looking Only at Yield
A 7% yield is not automatically better than a 4% yield.
Mistake 2: Assuming Preferred Dividends Are Guaranteed
Preferred status does not eliminate investment risk.
Mistake 3: Ignoring Interest Rates
Fixed-rate preferred securities can be sensitive to changes in market interest rates.
Mistake 4: Ignoring Call Provisions
A high-yield preferred security can potentially be redeemed by the issuer.
Mistake 5: Assuming All Preferred Stocks Are Identical
Terms vary considerably.
Mistake 6: Treating Preferred Stock Like a Savings Account
Market prices can decline substantially.
Mistake 7: Ignoring Inflation
A fixed dividend can lose purchasing power over time if inflation rises.
Common Stock vs. Preferred Stock: Which Should Beginners Own?
There is no single answer that applies to every investor.
But for a beginner building a long-term dividend-growth portfolio, common stock is often the more straightforward starting point.
Common stocks allow investors to participate in:
- Business growth
- Dividend growth
- Capital appreciation
- Voting rights
- Long-term compounding
Preferred stocks can be useful for a more specialized income strategy, but they require investors to understand additional factors such as:
- Call risk
- Interest-rate sensitivity
- Cumulative versus non-cumulative dividends
- Credit risk
- Liquidation preference
- Security-specific terms
Therefore, a beginner should not choose preferred stock simply because its yield is higher.
The better question is:
Does the security's risk and return profile match my investment objective, time horizon, and tolerance for price fluctuations?
Key Takeaways
- Preferred stock dividends generally have priority over common-stock dividends.
- Common stocks generally offer greater potential for dividend growth and capital appreciation.
- Preferred stocks often provide a stated dividend rate, but the dividend is not equivalent to a guaranteed payment.
- Preferred stocks can be sensitive to interest rates and issuer credit conditions.
- Callable preferred stocks carry redemption risk.
- Cumulative and non-cumulative preferred dividends have important differences.
- Beginners should not choose an investment solely because it offers a higher yield.
- Common stock may be easier for beginners seeking long-term dividend growth, while preferred stock can be considered for investors specifically seeking its income characteristics.
Frequently Asked Questions
What are preferred stock dividends?
Preferred stock dividends are distributions paid to holders of preferred shares. Preferred shareholders generally have priority over common shareholders when dividends are paid, subject to the specific terms of the preferred security.
Are preferred stock dividends guaranteed?
No. Preferred stock is equity, not debt. The exact rights and protections depend on the security's terms, and investors can still face dividend suspensions, price declines, issuer credit problems, and other risks.
Should I buy common stock or preferred stock for dividend income as a beginner?
For many beginners focused on long-term dividend growth and wealth building, common stock may be easier to understand and provide greater growth potential. Preferred stock may be appropriate for investors who specifically understand and want its income-oriented characteristics.
Do preferred stocks have higher dividends than common stocks?
Preferred stocks often have higher stated yields than many common stocks, but this varies by security and market conditions. A higher yield also comes with risks that should be evaluated.
Can preferred stock prices fall?
Yes. Preferred stock prices can decline because of interest-rate changes, deterioration in the issuer's financial condition, market conditions, call risk, and other factors.
External Sources
For additional research and security-specific information, investors should consult authoritative sources such as:
- U.S. Securities and Exchange Commission (SEC) — Investor education, filings, and securities information
- FINRA — Investor education and information about stocks and preferred securities
- Company investor-relations websites — Official preferred-stock terms, dividend announcements, and financial information
- Official prospectuses and offering documents — Security-specific dividend, call, conversion, and liquidation terms
- IRS — U.S. tax information concerning dividends and investment income
- Canada Revenue Agency (CRA) — Canadian tax information concerning investment income and dividends
For any specific preferred security, the prospectus and official security documents should take precedence over generalized descriptions.
Conclusion
Common stock and preferred stock can both play a role in an income-oriented portfolio, but they serve different purposes.
Preferred stock dividends can offer relatively predictable income and generally receive priority over common-stock dividends. However, preferred securities also carry risks involving interest rates, issuer credit quality, call provisions, liquidity, and security-specific terms.
Common stock generally offers greater participation in a company's growth and greater potential for dividend increases over the long term.
For a beginner asking “Should I buy common stock or preferred stock for dividend income?”, the answer should not be based solely on which security has the higher yield.
Instead, consider the purpose of the investment.
If the objective is long-term dividend growth and participation in business growth, common stocks may provide a more straightforward foundation.
If the objective is income and the investor understands the additional characteristics and risks of preferred securities, preferred stock may be worth evaluating as part of a broader portfolio.
The strongest dividend strategy is not necessarily the one with the highest current yield. It is the one that appropriately balances income, growth, risk, diversification, and long-term objectives.
Disclaimer
Dividend Investing Basics provides educational information and is not financial, investment, tax, or legal advice. Investors should conduct their own research and consider consulting a qualified professional before making investment decisions. Past performance does not guarantee future results.
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