Preferred stock is a hybrid security that sits between common stock and bonds: it pays fixed dividends like a bond, represents company ownership like a stock, and gets paid before common shareholders — but after bondholders — if the company goes bankrupt.
Most investors know two flavors of securities: stocks (ownership, variable dividends, big upside) and bonds (loans, fixed interest, paid first in bankruptcy). Preferred stock is the odd middle child that borrows traits from both. Companies — mostly banks, utilities, and insurers — issue it to raise money without taking on debt or diluting common shareholders too much. Investors buy it for one reason above all: steady, relatively high income.
How Preferred Stock Works
A share of preferred stock typically has a par value (often $25) and pays a fixed dividend — say, 6% of par, or $1.50 per year. That dividend is set at issuance and doesn’t grow the way a healthy company’s common dividend might. In exchange for the fixed payout, preferred shareholders usually get no voting rights and very limited price upside: the shares tend to trade in a band around par value, rising and falling with interest rates rather than with the company’s fortunes.
The “preferred” in the name refers to the pecking order. If the company pays dividends, preferred shareholders get paid before common shareholders see a dime. If the company goes bankrupt, preferred shareholders stand ahead of common shareholders in line for whatever’s left — but behind bondholders and other creditors, who get paid first. It’s a better seat than common stock, not a safe one.
Stock vs. Bond vs. Preferred: The Tradeoffs
Think of it as a spectrum. Bonds give you a contractual promise: interest payments are legally owed, and missing one is a default. Preferred dividends, by contrast, can be suspended by the board without triggering bankruptcy — painful for you, legal for them. (Cumulative preferreds must eventually make up missed payments before common dividends resume; non-cumulative ones don’t.) Common stock sits at the bottom of the priority stack but keeps all the upside.
So preferreds offer bond-like income with stock-like risk, and neither the safety of bonds nor the growth of stocks. That’s the honest bargain: yields typically run a few percentage points above the same company’s bonds, compensating you for the extra risk — the risk that dividends get cut and the price drops when rates rise or the company’s credit deteriorates.
The Two Features That Trip People Up
They’re usually callable. Most preferreds can be “called” — bought back by the issuer at par — after about five years. If rates fall, the company will happily refinance your 6% preferred with a new 4% one, and you get your $25 back and lose the income stream. Your upside is capped at par, but your call risk is very real. This is why preferreds rarely trade far above par for long.
They’re sensitive to interest rates. With fixed dividends and quasi-perpetual maturities, preferreds behave like long-duration bonds: when rates rise, their prices fall. In 2022’s rate shock, broad preferred indexes dropped roughly 15% — a nasty surprise for investors who thought of them as “safe income.” Anyone buying preferreds should understand they’re making a bet that rates stay contained.
Who Buys Preferred Stock?
Income investors: retirees and anyone building a yield-focused portfolio who can accept the rate risk. Preferreds make most sense as a slice of the income allocation — alongside bonds and dividend stocks — not as the whole thing. Concentration is a real danger here: the preferred market is dominated by financial companies, so a “diversified” preferred portfolio is still heavily exposed to one sector’s credit cycle.
Most individuals are better off owning preferreds through ETFs than picking individual issues. The two giants are the iShares Preferred and Income Securities ETF (PFF) and the Invesco Preferred ETF (PGX), each holding hundreds of preferred issues and yielding in the 5–6% range. VRP, the Invesco Variable Rate Preferred ETF, holds floating-rate preferreds for investors worried about rising rates. Individual preferreds are thinly traded and hard to research — the ETF route sidesteps both problems. Note that preferred dividends are often taxed as qualified dividends; see how dividends are taxed for the details.
What Would Buffett Think?
Warren Buffett has occasionally bought preferred stock himself — famously, Berkshire’s $5 billion investment in Goldman Sachs preferreds during the 2008 crisis, with warrants attached. But he was buying with downside protection and an equity kicker, on terms no retail investor gets. For ordinary investors, his broader lesson applies: know exactly what you’re being compensated for. Preferreds pay you extra yield for call risk, rate risk, and subordination. If you understand that trade and want the income, they’re a legitimate tool. If you thought you were buying something bond-safe, you’re in the wrong security.
The Bottom Line
Preferred stock is income with strings attached: fixed dividends that rank above common stock but can still be suspended, prices that sag when rates rise, and call provisions that cap your upside. Used knowingly — usually via a diversified ETF, as part of a broader income plan — it’s a reasonable way to boost yield. Just don’t mistake it for a bond.
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