Preferred shares take their name from the fact that they feature senior asset claims above those on common shares. Amid bankruptcy, preferred shareholders are to be paid prior to common shareholders from the proceeds of any asset liquidations. Preferred dividends are also prioritized. Missed preferred dividends accumulate, and the total must be paid out before common shareholders receive any dividends. Preferred stock asset claims, however, are junior to those associated with bonds.
Because of their senior asset claims, preferred shares are more conservative investments -- in comparison to common shares. As an investor, you may covet preferred shares for their relative stability and high dividend payments. Corporations are also frequent buyers of preferred shares. The IRS extends special tax breaks for U.S. corporations that receive dividends from other domestic corporations. Be advised that preferred shares do not carry voting rights.
Because of their junior asset claims, share of common stock are relatively high-risk, high-reward investments. In corporate bankruptcy, common shareholders receive cash from asset liquidation sales after both preferred shareholders and bondholders. Share prices for common stock therefore often collapse toward zero amid business bankruptcy. In terms of upside potential, however, prices for common stock can approach infinity. This dynamic is due to the fact that common stock valuations closely track business profits, which are unlimited. Due to the volatility, common stock investments are more ideal to build for long-term objectives, such as retirement and tuition expenses.
Shares of common stock do carry voting rights over the underlying corporation. As such, common stock investments are targets for large investors who seek management control. To control a company, an investor would purchase more than 50 percent of its outstanding common stock -- and votes. From there, the investor can replace the board of directors and hire a new management team. To buy a corporation outright, an investor would make an offer for all of its outstanding common shares.
Mutual Fund Shares
The Securities and Exchange Commission (SEC) recommends mutual funds for smaller investors, who seek out diversification and professional money management. One mutual fund share carries rights over a larger investment pool that owns hundreds of different securities. For active mutual funds, a management team regularly trades investments according to their views on the global economy. Index mutual funds, however, simply buy and hold a basket of securities to represent a particular business sector. Mutual fund shareholders can vote on issues affecting their particular fund, but are not voting shareholders of corporations held within the fund.