Common stock shares are the most pervasive type of equity investments that are available, but there is a downside to holding these types of shares that can make the asset class less appealing than other types of investment. The chief disadvantage is the risk of financial loss. While a certain amount of risk comes with any investment, some common stock shares run high risk. There are additional drawbacks that may not be obvious at the onset of investing, but can compromise your investment portfolio if you're not mindful of them.
One of the greatest drawbacks of being a common stock investor is the volatility that accompanies the equity markets. There's no real way to escape the ups and downs that stock investors endure. When you invest, you hope to share in a company's profits, but you become subject to its financial losses as well. If the price movements are too much for you as a common shareholder, you may wind up selling a stock without seeing it through to its full potential. If you decide to ride out extreme volatility, there's no guarantee it will resolve to the upside, so you could ride it out only to experiencing a financial loss.
If you're a dividend investor, you can be in for some unwelcome surprises as a common stockholder. Corporations aren't obligated to use their profits to provide you with cash-dividend incentives. When there is enough cash flow from which to pay dividends, preferred shareholders -- another investor type -- take priority for receiving those distributions. Also, since dividends, not rising stock prices, are a primary benefit of preferred shares, you'll be disappointed to learn that preferred shareholder dividends are often more generous than those paid to common shareholders.
While it may never be the intention of corporate executives to fool you, there are some financial maneuvers they can use that make their profits appear stronger than they actually are. A share buyback is one such event. By repurchasing shares of their own common stock, corporations are lowering the "float," or number of shares available for you to buy. In turn, in light of the fact that there are now fewer shares outstanding, the share buyback improves the relative amount of profits earned for each outstanding share of stock, according to a 2012 CNN Money article.
A bankruptcy situation is regretful for equity and debt investors alike, but the fallout can be especially punishing for common stock shareholders. Once a company becomes insolvent, it is usually required by a bankruptcy court to use remaining assets to pay creditors. Typically, this means that a company's suppliers are paid first, followed by holders of the company's debt. Even preferred shareholders are paid before any potential remaining funds are distributed to common shareholders.
- Goodshoot/Goodshoot/Getty Images
- Difference Between Outstanding and Fully Diluted Stock
- What Is the Main Difference Between a Bond and a Share of Stock?
- Understanding Stocks & Shares for Beginners
- How Does a Stock Split Work?
- Reverse Stock Split Rules
- How to Pick Micro-Cap Stocks
- How Does a Stock Split Impact Shareholders' Equity?
- The Eligibility Requirements for Shareholders in the Subchapter S Corporation
- How to Add Up Your Stock Shares
- How to Calculate the Common Stock Account Balance After a Stock Split