You probably hear about the stock market a lot, but if you’ve never bought and sold stocks before, then it can seem overwhelming and abstract. You might be picturing the chaos of Wall Street brokers yelling at each other on the floor of the stock exchange.
And you may be unsure about all the different categories of things you can trade: commodities, futures contracts, common stock, preferred stock. What’s the difference?
One good place to start is by learning about common and preferred stocks. Publicly traded companies issue common stock with some also issuing preferred stock.
You can buy stocks in many different companies that are publicly traded, depending on what you want out of your investments. There are a number of considerations when choosing a stock to buy.
But before you start buying and selling stocks—whether they’re common or preferred—you may want to know some of the basics, like how the stock market works and what a stock is.
A General Overview of Stocks
A stock is an ownership share in a company. When a business wants to raise money, it can issue stocks.
You can buy a stock in exchange for a percentage ownership of the company. Stocks can go up or down in value based on many factors, including the financial health, future, and revenue of the company.
If you sell a stock at a higher price then you bought it, then you would make a profit on that stock. Stocks can also pay dividends to shareholders if the company is profitable and chooses to do that. Your total return on a stock includes an income from the investment, like dividends, and any change in the value of the stock.
Companies can issue common stock or preferred stock. Both can be bought, sold, or traded on exchanges. There are many exchanges and markets all over the world.
If a company is “listed” on an exchange, it means stocks in that company are primarily traded on that exchange. (Not all stocks are listed on all exchanges, because each exchange or market has its own rules and regulations.)
When someone talks about the stock market, they’re typically referring to the overall trends of stocks across all the markets and exchanges.
One of the common ways this is tracked is via a market index. An index weights a selected set of stocks to create an average value, which can be tracked over time to see ups and downs.
For example, the S&P 500 calculates the stock values of 500 of the largest U.S. companies’ market capitalization. The Dow Jones Industrial Average is made up of 30 large publicly traded U.S. companies.
The reason this all works is because people have different ideas about which stocks will go up, which will go down, and when. That means one person might be willing to buy a stock when another person wants to sell.
The value of a stock depends on what people are willing to pay for it, which is usually based on things like the company’s revenue potential, earnings versus debt, and any profit or dividend it pays out.
When considering buying a stock, you may want to research the financial background and info of the company whose stock you’re considering buying.
There are different ways to evaluate a stock: income revenue and expenses, the balance sheet, cash flow, industry prospects. You may even want to consider things like price-to-earnings ratio and return on equity.
Before buying your first stock, you may want to understand the various stocks available, and their benefits and risks.
Preferred Stocks vs. Common Stocks
What are Common Stocks?
Common stock is what people generally think of when they refer to a stock. All publicly traded companies issue common stock, which provides you a share in a company with the requisite voting rights in that company.
Common stocks can offer dividends, if the company chooses, and can also increase (or decrease) in value based on the price of the stock.
If a stock increases in value from when you bought it, then you may be able to sell the stock for a profit.
But dividends are only paid out if the company decides to distribute earnings via dividends to shareholders. And if the company goes bankrupt, common stockholders will be paid last, if at all, after creditors and preferred stockholders.
What are Preferred Stocks?
A preferred stock also represents a share in a company, but is a bit like a cross between a regular stock and a bond. Preferred stock offers dividends, which are set in advance and have priority.
Those dividends are often a fixed amount, but can be adjustable based on preset specifications. (Dividends on common stock vary based on the company’s finances.)
That means preferred stockholders are paid their dividends whether the stock loses or gains value.
If a company chooses to miss dividend payments, then they must make up all the payments later, before paying out any dividends to common stockholders. This guarantee makes preferred stock less volatile, but also potentially less profitable.
Preferred stock also gives preferential treatment in the case of a corporate bankruptcy or collapse. Preferred stock, however, does not generally come with voting rights and the company can buy back preferred stock at the predefined price.
One important note: Convertible preferred stock can be converted to common stock in a few scenarios: if the board of the company votes for a conversion, if you decide to convert based on the price of the stock, or if it converts at a predetermined date.
Benefits and Drawbacks
Both common and preferred stock have benefits and drawbacks, and both can be good investments depending on what you’re looking for.
Preferred stock typically pays higher dividends than common stock, because they’re set at the time the stock is issued. However, if the company decides to issue a larger dividend, then the dividend on a common stock could go above the dividend on a preferred stock.
This typically makes preferred stocks less volatile than common stocks—though still more volatile than a bond. Like a bond, a preferred stock can also be called back.
That means the company can decide to buy back your preferred stock at any time, at a preset price. They may choose to do this when the stock prices rise, so they can buy the stock back before the price goes up.
Because preferred stocks have many similarities to bonds, their value is also related to interest rates. As interest rates rise, preferred stock becomes slightly less valuable because other investments can appear to be more valuable.
Common stock doesn’t guarantee a dividend, which means it won’t provide a set income. However, the value of a common stock can rise and fall more quickly than preferred stock, and can go higher than the preferred stock.
The value of a stock is not necessarily tied to its current market price; the value can be tied to the company’s price-to-earnings ratio, its assets versus liabilities, or its growth rate.
An individual common stock’s value can go up or down depending on the company. That makes common stock riskier and more volatile, but also with a higher potential payoff or loss.
One of the things that makes preferred stock slightly less risky is what happens in the case of a company becoming insolvent. If a company has to declare bankruptcy and pay creditors and bondholders, then preferred stockholders are paid first and before those who have common stock in the company.
Depending on what company you want to invest in, how much you’re choosing to invest in one specific company, and how concerned you are about that company collapsing, this could be an important benefit.
The voting rights that come with common stock may not be especially valuable unless you own enough stock to have a significant percentage of voting rights. Though the breadth of a stockholders voting rights varies from company to company.
While every publicly traded company offers common stock, not every company offers preferred stock.
There are only about 120 high-quality preferred stocks for sale.
Get Started Buying Stocks
Most of the time when people want to buy or sell stocks, they go through a broker who is licensed to trade on the exchanges. There are also a growing number of online brokerages, which allow you to make individual trades yourself or invest in a diversified fund made up of a mix of stocks, bonds, and other assets.
Preferred and common stock are sold through brokerage firms. In general, it’s easier to access common stock, but both can be bought through ETFs (exchange-traded funds) as well.
An ETF is similar to a mutual fund, except traded on the exchange, giving you diversified access to a number of assets that you might not otherwise be able to buy in full. Stocks are offered in ETFs on their own, in ETFs that track market indices, and even in diversified ETFs that offer a mix of stocks and bonds.
There are preferred stock ETFs, which offer the ability to buy a share of the ETF, granting a proportionate share of all the preferred stocks that make up that ETF.
If you’re preparing to invest in the stock market, it’s important to know that the market fluctuates regularly, with the prices of stocks going up and down. That means you may need to be patient to see a long-term benefit.
On average, the typical stock market returns about 10% annually—but that doesn’t mean your stocks will give you a 10% return, nor does it mean any given year will have a return.
When the market rises or falls it doesn’t necessarily mean an individual stock will rise or fall, though often a market drop can precipitate an economic crash because it can reflect larger economic issues and can also erode consumer confidence.
When considering whether you should buy or sell your specific stock, you’ll likely want to consider your overall financial goals and timeframe, what portion of your portfolio is made up of stocks, and how the stock’s underlying financials hold up.
Getting Help With Investing
If this all sounds a little complicated, then professional advice can also help you figure out how stocks—both preferred and common—can fit into a diversified portfolio that helps you achieve your financial goals.
SoFi Invest® offers both active investing and automated investing, which means you can either pick and choose your own stocks or you can have an algorithm help set you up with an investment portfolio tailored to your risk tolerance and goals—without a SoFi management fee!
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