Preferred stocks often pay higher, steadier income than regular dividend stocks, but they come with quirks like call dates and interest-rate risk. Here's how they work and whether they belong in a passive income plan.
If you've been building a passive income plan, you've probably looked at dividend stocks and bonds. But there's a lesser-known investment that sits right between them: preferred stock. Preferreds often pay noticeably higher yields than typical dividend stocks, and their payments are usually fixed, which makes them attractive to people who want predictable income. They also come with some unusual features that can catch beginners off guard. Here's a plain-language guide to what preferred stocks are, how they make money for you and where the risks hide.
When a company raises money, it can sell regular shares (called common stock), borrow money by issuing bonds, or sell something in between: preferred stock.
Preferred stock gets its name because its holders get "preference" over common shareholders in two ways:
Dividends come first. The company must pay preferred dividends before it can pay any dividend on its common stock.
Priority in bankruptcy. If the company goes under, preferred holders get paid before common shareholders (but after bondholders).
In exchange, preferred shareholders usually give up two things: voting rights, and most of the upside if the company's business booms. A preferred share's price tends to hover near its "par value," often $25, and doesn't soar the way a hot common stock might.
That's why people describe preferreds as a hybrid. They behave a lot like a bond, paying fixed income and trading around a set price, but they're technically equity, like a stock.
Most preferred stocks pay a fixed dividend, usually quarterly, set as a percentage of par value. A preferred with a $25 par value and a 6% dividend rate pays $1.50 a year per share, or $0.375 each quarter.
In 2026, many investment-grade preferreds from large banks, insurers and utilities have yields commonly in the 5% to 7% range, though this moves with interest rates and credit quality. That's often higher than the average dividend yield on the broader stock market and competitive with many corporate bonds.
A few terms you'll want to know:
Cumulative vs. non-cumulative: If a company skips a dividend on a cumulative preferred, it owes you that missed payment later before paying common shareholders. With non-cumulative preferreds, a skipped payment is simply gone. Cumulative is safer.
Call date: Many preferreds can be "called," or bought back, by the company at par after a certain date, often five years after issue. Companies tend to do this when interest rates fall, which means you might lose your high-yielding investment right when replacements pay less.
Fixed-to-floating: Some preferreds pay a fixed rate for several years, then switch to a floating rate tied to a benchmark. These can hold up better when rates rise.
Qualified dividends: Many, but not all, preferred dividends are "qualified," meaning they're taxed at the lower long-term capital gains rate if you meet the holding period.
You can buy individual preferred shares through most brokerages, but they can be tricky. Each one has its own call date, credit rating and terms, and some trade thinly, which makes buying and selling at fair prices harder.
For most beginners, a preferred stock ETF is simpler. These funds hold dozens or hundreds of preferred issues, spreading out risk. Well-known examples include the iShares Preferred and Income Securities ETF (PFF) and the Invesco Preferred ETF (PGX). You can explore low-cost fund options on our low-cost investing page. Keep in mind ETFs charge an expense ratio and their price will still move with interest rates.
If you're comparing preferreds to other income options, see our guides to dividend investing for passive income and bond ladders vs. bond funds.
Interest rate risk. Like bonds, preferred prices usually fall when interest rates rise. A preferred paying 5% looks less appealing when new ones pay 7%, so its price drops.
Call risk. As mentioned, companies can redeem preferreds when rates fall, limiting your upside.
Concentration in financials. A large share of preferred stock is issued by banks and insurance companies, so a banking crisis can hit preferreds hard. This happened in 2008 and briefly again in 2023.
Credit risk. If a company struggles, it can suspend preferred dividends. Check credit ratings.
Limited growth. Don't expect preferreds to grow your wealth the way stocks can over decades. They're an income tool.
Grace, 62, is two years from retirement and has $200,000 in a taxable brokerage account. She wants more income without putting everything in bonds. She puts $40,000 into a diversified preferred stock ETF yielding about 6%. That generates around $2,400 a year in dividends, or $200 a month. When interest rates ticked up in one year, the fund's price dropped about 5%, but Grace kept collecting her income and didn't sell, and the price gradually recovered as rates settled.
Omar, 38, got excited about a single bank's non-cumulative preferred paying 8.2%. He put $15,000 into it, expecting $1,230 a year. Eighteen months later, the bank's earnings slumped and it suspended the preferred dividend. Because the shares were non-cumulative, those missed payments were gone for good, and the share price fell to about $17 from $25. Omar's $15,000 was worth around $10,200. The lesson: a sky-high yield on a single issue is often a warning sign, and diversification matters.
Chasing the highest yield. Unusually high yields often signal higher risk of a dividend cut.
Ignoring call dates. Buying a preferred above par right before its call date can mean an instant loss if it's redeemed at $25.
Putting too much in one issuer or sector. Spread it out, ideally through a fund.
Treating preferreds as risk-free. They're less volatile than common stock, but they can and do fall.
Forgetting about taxes. Not all preferred dividends are qualified. Holding them in an IRA can simplify things.
Using debt to invest. If you're carrying high-interest credit card balances, paying those off will almost always beat a 6% yield. A balance transfer card can help you get there faster.
Decide what role you want preferreds to play, usually a slice of your income portfolio, not the whole thing.
Start with a diversified preferred ETF rather than individual issues. Our beginner investing page can help you choose a brokerage.
Check the fund's yield, expense ratio and sector mix.
Consider holding preferreds in a tax-advantaged account if their dividends aren't all qualified.
Reinvest dividends if you don't need the income yet.
Review once or twice a year, especially after big interest rate moves.
Preferred stocks can be a useful middle ground for passive income investors: more yield than most dividend stocks, more stability than common shares and a fixed payment schedule you can plan around. But they're sensitive to interest rates, can be called away and are heavily tied to the financial sector. For most people, a diversified preferred ETF held as one piece of a broader income strategy is the simplest way to get the benefits without taking on too much single-company risk.
This article is for informational purposes only and does not constitute investment advice. Investing involves risk, including possible loss of principal. Yields and fund details mentioned are illustrative and can change. Consider consulting a qualified financial professional before investing.
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