One of the most basic understandings in regards to being an investor is knowing the asset classes you can choose from. For the sake of staying on point with stocks, we will take a look at the 3 main paper asset classes most investors use which are stocks, bonds, and cash. Stocks are referred to as equities or securities. They are called equities because as an investor you are purchasing equity or ownership in a company. That’s right, as an investor when you purchase shares or equity in a company you are officially an owner or shareholder of that company and you should look at it that way.
There are two types of stock you can pick from and they are common stocks and preferred stocks. Knowing the difference between these two types of stocks is necessary so that you actually know what kind of stock you are investing in as well as knowing what the advantages and disadvantages are with each type of stock.
Let’s look at preferred stocks!
What is a preferred stock or a preffered share? Preferred stock is a stock that entitles the holder to a FIXED dividend, whose payment takes priority over that of common stock. A better way of wording this would be that it’s a class of ownership in a corporation that has a higher claim on its assets and earnings. Below we will list out some of the advantages and disadvantages of owning preferred stock.
- You are the first to get paid!
- They offer terrific yields.
- Trust types of preferred stock give an increased safety of bonds with the liquidity of stocks.
- The dividend is FIXED meaning the shareholder will never have the dividend taken away.
- They are harder to buy. Typically they are issued to upper levels of management in a company such as the CEO, CFO or (insiders).
- Information on them isn’t as readily available to the public. This makes it difficult for retail investors to know when to buy or sell them.
- Stock brokers a lot of times have a hard time even understanding them or their prospectus.
Now let’s take a look at common stocks!
Common stocks – Are shares entitling their shareholder to dividends that vary in distribution amounts and may even miss at times depending on the fortunes of the company. Typically these are the types of stocks that are sold through a broker. It is important to remember that just because a company pays out a dividend to its shareholders today does not guarantee that it will pay out a dividend to its shareholders tomorrow.
The best way to look at buying common stock according to guys like Warren Buffet is like this; stocks are volatile so we know that the price will go up and down right? People want to sell as soon as they see the price start dropping most of the time.
Most people are speculators, they look at their stock NOT as an asset that produces cash flow for them. They usually pay attention only to the price. Instead of focusing on the price, treat the asset like you would treat the value of your home. If your realtor came to you days after you bought your home and said, “it has dropped .05% or 1%”, you wouldn’t just sell your home would you? So why should you sell your stock if you are an owner of a company with the intention of accessing cash flow from it or building equity from it?
Rule of thumb is that if you are purchasing common stock or any stock for that matter, you should hold onto it for at least 10 years. Even if it cuts a dividend hold onto it because the dividend can always be reinstated and in most cases, usually is, if it is cut at one point in time.
- Protected against liability stemming from company actions beyond financial investments in the company.
- Usually offers higher yields.
- Easier to Buy.
- Easier to access information on the stocks.
- It’s easier for brokers to understand them and their prospectus.
- Only comes in 1 flavor.
- The shareholder is the last to get paid.
- Dividends can be cut at any time.
If you have further information on preferred stocks and common stocks feel free to share in the comments below.