Part 1: What are Preferred Stocks, How They Change in Price, Different Types of Preferred Stock
Part 2: Pros and Cons of Preferred Stock, Should You Buy Preferred Shares
Introduction to Preferred Stocks for Kids and Teens
This video explains the concept of Preferred Stocks a simple, concise way for kids and beginners. It could be used by kids & teens to learn about preferred stocks, or used as a money & personal finance resource by parents and teachers as part of a Financial Literacy course or K-12 curriculum.
Suitable for students from grade levels:
- Elementary School
- Middle School
- High School
The topics covered are:
- What are preferred stocks
- How do preferred stocks change in price
- Are there different types of preferred stock
- Pros / advantages of preferred stock
- Cons / disadvantages of preferred stock
- Should you buy preferred stock
What are preferred stocks?
Preferred stocks, also known as preferred shares, are hybrid securities that combine features of both stocks and bonds.
Like a regular stock, a preferred stock represents ownership rights. But like a bond, preferred stock provides fixed income in the form of dividends.
They are called preferred stocks due to the preferential treatment given to their holders compared to common stockholders when it comes to paying dividends, as well as in the event of bankruptcy.
Preferred stocks are more prevalent in the financial sector, and are commonly issued by banks, insurance companies, real estate investment trusts or REITs, etc.
How do preferred stocks change in price?
When it comes to pricing, preferred stocks are very similar to bonds. They are issued at face value or par value, which is the basis for dividend payout.
Their price changes slowly and is linked to market interest rates. This makes their price more stable and less risky, but also limits their upside.
Are there different types of preferred stock?
There are a few different types of preferred stocks, but the 3 most popular ones are Cumulative, Callable, and Convertible.
Cumulative preferred stocks accrue dividends – which means if the company is unable to pay any portion of the fixed dividend, the payment is postponed – but all outstanding dividends must be paid to preferred stockholders before any dividend is paid to the common stockholders.
Callable preferred stocks provide the company an option to buy back the preferred stocks from the shareholders after a certain date, at face value or at a slight premium.
Convertible preferred shares can be converted to common stock at predetermined terms.
What are the advantages of preferred stock?
Preferred stocks are less risky than common stock while providing higher regular dividends. The dividends are also higher than bond interest, since they are riskier than bonds.
So preferred stocks can be used for income investing, if you want a steady stream of income.
Another advantage of preferred stocks is the preferential treatment given to their holders if the company goes bankrupt.
Also, when the company buys back callable preferred shares at a premium, the stockholders may get more than what they paid.
And in the case of convertible preferred shares, if the common stock has shot up in price, preferred shareholders can benefit from the gain.
Are there any disadvantages of preferred stock?
The main disadvantage of preferred stock is that unlike common stock, the potential for capital gain is limited since the price fluctuations are not drastic.
While their fixed payouts make them similar to bonds, they are much riskier – and unlike bonds, the payments aren’t guaranteed.
Also, preferred stock holders may not get voting rights, limiting their say in the company’s decisions.
And since preferred stocks are not very common, their overall market size is small, making them less liquid and difficult to trade.
Should I buy preferred stock?
If you want to invest for capital growth, you should buy common stocks. If you want to invest for income, you should buy bonds. There is really no need to invest in preferred stocks!
If you really want to invest in preferred stocks, you can do it using a preferred stock Exchange Traded Fund (ETF) or mutual fund. This way, your portfolio can have a diversified collection of preferred stocks, thereby minimizing your risk.