What is a bond?
In broad terms, a bond is a loan you give to a company. They pay you dividends, and at the end of a set period of time, you cash in the bond for the face value. In general, bonds are a low-risk, low-yield investment. You make your money based on the interest you receive, and on the fluctuations in the bond value.
What is a preferred stock?
Preferred stock is stock that has a higher claim on being paid out than a regular share. When companies go to pay back the people who have given them money, bonds have top priority, then preferred stock, then common stock. Preferred stock usually comes with a sacrifice - you don't typically get voting rights. Preferred stock is often referred to as a "hybrid asset" because it has qualities of both a bond and common stock. It gets paid out in fixed dividends like a bond does, and if you don't get paid, you can often receive payment in arrears before regular shareholders get paid. That means there's less risk than common stock, but the payoff is lower because it's linked to the company's performance instead of to the trading price. Unlike bonds, preferred shares either don't mature, or mature over extremely long periods.
Who issues bonds?
The federal government, local governments, and companies can all issue bonds. Companies have a rating system for how reliable their bonds are, just like people have credit scores, that can help you determine if a bond is a smart investment based on how much risk you like to take on. Many companies offer bonds to launch new products or enter new markets.
Who issues preferred stock?
Usually a company issuing preferred stock is either in really good shape or really bad shape. A less credit-worthy company may issue preferred shares because regulations won't let them take on more debt. A more credit-worthy company might issue preferred shares to finance a specific project. Like bonds, preferred stock is rated by agencies based on the company's performance, which theoretically gives you some assurance about what you're getting yourself into.
What's the upside?
Well, both offer lower risks (and rewards) than common shares, but both still have their risks. Both can be "called" if the interest rate tips too far in your favor - the business is basically refinancing, and you can wind up worse for wear because of it. If the business fails, bondholders have more claim to the assets, and they get paid first. Neither payoff is tied to the stock price - bonds have interest rates until they mature, and preferred stock is tied to company performance. What this means is that if the stock value soars, you still won't make a ton of money with either of these investments.
Which is better?
Many people look to preferred stock as a way to make more money than bonds from a position of relative safety. And while that can be the case, there are still some bad things that can happen - the stock can get called, and the long maturity period is pretty unappealing. The best option for you depends on how much risk you're willing to take on, but in general, the risk/reward ratio seems to generally fall in favor of bonds.
