The Investment Pecking Order

The economy is in a slow period, and bankruptcies are making headlines. So, lately, I’ve been fielding a lot of questions about the pecking order investors assume when a publicly traded company goes into bankruptcy.

Here’s what you need to know…

  • First, debt holders get their money before equity holders. In other words, people holding the bankrupt company’s corporate bonds will be paid in full before anyone holding the stock sees a penny. This doesn’t mean that bondholders always get paid in full – just that they get paid before stockholders.
  • If the company has preferred shares, holders of those shares get paid before holders of the common shares. Most of the stocks that are reported on by CNBC and in the financial section of your local newspaper are common shares.
  • Who gets paid last? Usually, it’s you, the common investor.

This pecking order isn’t a concern most of the time. But with companies like Fannie Mae and Freddie Mac teetering on the brink of disaster, it certainly deserves your attention. Should Fannie and Freddie get consumed by the federal government, it could come into play.

As is always the case, you need to do your homework before you invest. If you are looking at investing in a company that has a lot of debt and preferred shares, beware. If the company gets in trouble, you will be the last in line to be paid if you invest in its common shares. You can protect yourself by shying away from companies with lots of debt.

[Ed. Note: Making smart investment choices is the best way to protect your money. Companies with strong fundamentals are best equipped to withstand major market changes. But don’t be afraid of small fluctuations in the market. ]