For many investors this year, bond markets and stock markets have felt treacherous. If you want to trim your exposure to stocks but don’t want to reinvest the money in conventional bonds, convertible bonds may be a good solution. Convertible bonds are a hybrid investment that, like traditional bonds, offer fixed-interest payments and the return of your principal at maturity (as long as the issuer does not default). But convertibles also give you some potential for stock market gains. If you own a convertible bond issued by a company, you have the option of exchanging it for a specific number of shares of the company’s stock once the stock hits a specified price. Because of this conversion option, the value of convertibles tends to rise when the issuer’s common stock does. On the other hand, if the price of the common stock falls, you’re protected. You can hold on to your convertible bond and continue to get a steady flow of income, as well as the eventual return of your principal, no matter how poorly the stock does (again, as long as the issuer does not default).
Drawbacks: Convertibles typically capture only one-half to two-thirds of the underlying stock’s appreciation. They also tend to pay lower interest rates than traditional corporate bonds.
Because convertibles can be complex to analyze and to trade, it may be best to invest through a mutual fund. For a list of convertible funds and their performance, go to Snip.ly/QWNH.
