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What Is Common Stock and What Is Preferred Stock? Stock Types and Their Differences Explained

Which Type of Stock Should You Pick?

Wow, our jeep just rounded a clearing, and there they are -- a pride of lions (stocks). It's interesting -- there seem to be two really different types. The two types of lions we're looking at are preferred stocks and common stocks.

"What's the difference?," you ask.

Remember, regardless of which type of stock you buy, purchasing stock makes you a part owner, or shareholder, of a company.

Let's Begin With Preferred Stock.

Companies that sell preferred stock are actually offering a blend of a more aggressive investment (stock) and a more conservative one (bond). This combination means that the price of preferred stock does not fluctuate as much as the price of common stock. That's why many risk-averse investors favor preferred stock.

Another advantage to owning preferred stock is that it almost always pays a dividend to shareholders.

Companies pay dividends to preferred stock shareholders before they pay dividends to common-stock shareholders.

Dividends accumulate if the company's board of directors decides to put a freeze on divvying up profits because it doesn't have the financial resources.

If the company goes bankrupt, preferred stockholders have a claim to any assets ahead of common stockholders.

On the other hand, preferred stockholders don't have any voting rights. To many investors, this doesn't really matter, but if, as an owner, you are passionate about management decisions at the company, you may want the right to vote. If so, then preferred stock is not for you.

Now Let's Talk About Common Stock.

Common stock, which is sold by most companies, is the only "pure" form of stock in the market. It's what people are talking about when they just mention "stocks." Because common stock has the potential for greater returns, investors buy it more often than they do preferred stock.

Common stock represents an equity ownership in the company and entitles shareholders the right to vote on management issues at the annual shareholder's meeting.

Common stockholders may, or may not, receive dividends, depending on management's decision about distributing profits.

Many beginning investors believe that preferred stock is better than common stock, but that's not necessarily the case. Your decision to purchase one over the other depends upon your financial goals, your tolerance for risk, and your interest in voting rights in the company.

Because most investors are interested in price appreciation, they usually purchase common stock. You get more "bang for your buck." It's that simple -- and so is our goal for you: to get the returns you need to fund your dreams. That's why we wrote this guide.

So, from this point on, whenever we refer to "stock," we mean common stock. A little later, we'll begin to learn about specific kinds of stocks that are best for you, such as growth-producing or income-producing.

Right now, though, you're ready to step a little further along the trail.

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