Typical investor

Only investors seeking income are suitable for preferred stock. If the investor is only interested in capital appreciation (capital gains), they should probably invest in common stock. Of course, convertible preferred stock offers capital appreciation potential, but the conversion feature is an added benefit, not the primary benefit (the primary benefit is income). From here, we can discuss the nuances.

Investors seeking income are typically risk averse (want to avoid risk). As established by the rule of 100, investors should generally invest more in fixed income securities the older they get. Therefore, it can be assumed preferred stock investors tend to be older and safer with their investments.

However, we learned of the risks involved with preferred stock investments in a previous section. In particular, dividend income is not guaranteed and can be skipped or suspended by the Board of Directors (BOD). Because of this, you can assume investors face moderate risk when they purchase preferred stock. Preferred stock is less risky than common stock but riskier than your typical debt security (e.g. bonds).

Therefore, the most conservative and risk-averse investors tend to avoid preferred stock, and instead invest their money into safer fixed-income securities like US Government debt. The potential for dividends to stop being paid and/or fluctuations in market price are too much of a risk for this type of investor. If a moderate or fairly conservative investor wanted to take on a little more risk in return for a higher income, preferred stock would be a suitable choice.

Preferred stock does not have a maturity or expiration, so investors should expect to be invested for long periods of time. While it can be callable or sold in the secondary market, most investments in preferred stock last for years. With income as the primary benefit, it takes time to collect a substantial amount of dividends as most shares make quarterly payments. Also, interest rates could rise considerably, driving the market values of preferred shares down. Investors with short-term time horizons might be forced to sell their shares at a low price if this were to occur. Long-term time horizons allow investors to collect dividends over time and to withstand market price fluctuations due to interest rate changes.

Corporations are big investors in preferred stock. As we learned in the benefits section, corporations obtain at least a 50% exclusion on the dividends received from stock investments. If a corporation has money available for investment and is seeking income, preferred stock offers a tax-advantaged investment opportunity.