Today we resume our occasional series on basic investment concepts with an introduction to preferred stocks. These securities have existed since the 19th century but remain a relatively misunderstood asset class. Like any investment, preferreds carry certain risks but can also provide consistent income subject to certain qualifications and the usual caveats relating to understanding the fundamentals.
Until the early 1800s, all shares of a company’s stock were equivalent and paid the same dividend. By 1836, railroads were expanding and needed additional capital. Too much debt would magnify risk, but issuing new stock diluted existing shareholders. The solution was a new class of security called a preferred stock, a hybrid that fell in between bonds and common equities.
Preferred shares (also called “preference shares” in Great Britain) paid a consistent dividend that could not be changed, unlike common stocks. In exchange for this regular income stream, preferred shareholders gave up voting rights.
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