Key Takeaways
- Preferred stocks pay fixed dividends at higher rates than common stock, typically 4-7%
- Preferred dividends are paid before common stock dividends
- They behave more like bonds than stocks, with limited price appreciation
- Callable preferred stocks can be redeemed by the issuer, creating reinvestment risk
Preferred stock is a hybrid security that sits between bonds and common stock. It pays a fixed dividend — usually expressed as a percentage of its par value — and those payments take priority over common stock dividends. If you are seeking higher current income with less volatility than common stock, preferred shares deserve consideration.
How Preferred Dividends Work
Most preferred stocks have a par value of $25 and pay a fixed annual dividend, such as 6% of par ($1.50/year). The dividend is typically paid quarterly. Unlike common stock dividends, which can be raised or cut at management's discretion, preferred dividends are fixed at issuance and do not grow over time. This makes them attractive for current income but poor for long-term income growth.
Types of Preferred Stock
- Cumulative: If the company misses a dividend, it must pay all missed dividends before resuming common stock dividends. Most preferred stock is cumulative.
- Non-cumulative: Missed dividends are lost forever. Less common and less desirable for investors.
- Callable: The issuer can redeem shares at par value after a specified date, typically 5 years after issuance.
- Convertible: Can be converted into a specified number of common shares.
Risks and Considerations
The biggest risks are interest rate sensitivity (preferred prices fall when rates rise, like bonds) and call risk (the issuer redeems your shares when rates drop, forcing you to reinvest at lower yields). Preferred stockholders also have no voting rights and limited upside — they do not benefit from the company's growth the way common shareholders do. For a broader look at income investments, see our types of dividends guide.
Frequently Asked Questions
Are preferred stock dividends taxed differently?
Many preferred stock dividends qualify for the lower qualified dividend tax rate if the holding period requirement is met. However, preferred dividends from REITs are typically taxed as ordinary income.
How do I buy preferred stocks?
You can buy individual preferred issues through any brokerage, or invest in preferred stock ETFs like PFF (iShares Preferred & Income Securities) or PGX (Invesco Preferred ETF) for diversification.
What happens if a company goes bankrupt?
Preferred shareholders are paid after bondholders but before common shareholders in a liquidation. However, in practice, recovery rates for preferred shareholders in bankruptcy are typically low.