Typical investor

Preferred stock is generally suitable for investors who want income. If an investor is focused mainly on capital appreciation (capital gains), common stock is usually a better fit. Convertible preferred stock can offer some capital appreciation potential, but the conversion feature is typically a secondary benefit - the primary benefit is still income.

Investors who seek income are often relatively risk averse (they prefer to avoid risk). Under the rule of 100, investors generally allocate more to fixed-income securities as they get older. For that reason, preferred stock investors are often assumed to be older and more conservative.

At the same time, preferred stock isn’t risk-free. As discussed in a previous section, dividend income is not guaranteed. Dividends can be skipped or suspended by the Board of Directors (BOD). Because of this, preferred stock is usually considered a moderate-risk investment: it’s generally less risky than common stock, but riskier than typical debt securities (e.g., bonds).

That’s why the most conservative, highly risk-averse investors often avoid preferred stock and instead choose safer fixed-income securities such as US Government debt. For these investors, the possibility of dividends being suspended and the potential for market price fluctuations may be too much risk. If a moderate or fairly conservative investor is willing to take on a bit more risk in exchange for higher income, preferred stock can be a suitable choice.

Preferred stock typically has no maturity or expiration date, so investors should expect a long holding period. While it may be callable or sold in the secondary market, many preferred stock investments are held for years. Since income is the primary benefit, it often takes time to collect a meaningful amount of dividends, especially because most preferred shares pay dividends quarterly.

Time horizon also matters because preferred stock prices can be sensitive to interest rates. If interest rates rise significantly, the market value of preferred shares may fall. Investors with short-term time horizons could be forced to sell at a low price in that situation. Longer time horizons give investors more opportunity to collect dividends over time and to ride out price fluctuations caused by interest rate changes.

Corporations are also major investors in preferred stock. As explained in the benefits section, corporations receive at least a 50% exclusion on dividends received from stock investments. So, if a corporation has funds available and is seeking income, preferred stock can provide a tax-advantaged opportunity.