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Does the thought of investing in the
currently volatile stock market make you cringe with worry about risking your hard-earned
dollars? Yet you know that keeping your money in a bank savings account or certificates of
deposit may also not be the best long-term strategy? Although certificates of deposit are
currently yielding between six and seven percent, the stock market certainly outperforms
them in the long run. Even the bond market typically outperforms bank securities. If
you're worried about the risk inherent in the stock market, then what's an investor to do?
Perhaps building a portfolio around a core of bonds is the best answer. Bonds have a lower
level of risk than stocks but also a lower return. However, with bonds, you get the added
benefit of a steady stream of income in the form of interest payments. With stocks, you
are not guaranteed a steady stream of dividend income. With traditional Treasury or
corporate bond investing, however, you may miss out on the higher returns generated in the
stock market. How can you solve this dilemma?
A special type of security, the convertible bond, will allow you the protection of bond
investing with the increased return and zip of stock investing. Convertible securities are
hybrids - half bond and half stock. The beauty of investing in convertibles is that they
offer you both regular income from the bond and downside protection from falling stock
prices. But, they also allow you to take advantage of the opportunity to earn higher
returns, as you might in the stock market, through generating capital gains. A convertible
security is simply a share of preferred stock or a bond that can be converted into common
stock by the owner. You don't even have to miss out on the technology craze by investing
part of your money in convertible bonds as opposed to stocks. Technology companies are big
fans of convertible securities. Most of the convertibles issued in 1999 and 2000 have been
by technology companies. Sounds like the best of both worlds! The protection of a bond
with the benefits of a stock, even a technology stock.
Even in down markets like we've had in 2000, convertibles pay interest income. If the
underlying stock price takes a nosedive, the convertibles market value will be
approximately that of the bond with a comparable rating and yield -- currently about 4.3
percent. Common stocks pay an average dividend of only about 1.3 percent. On the other
hand, if the underlying stock price rises, you can pay a conversion premium and convert
your bond to stock. But, given the choice, most convertibles investors never convert? Why?
They choose to keep a portion of their portfolio allocated to convertible securities for
that downside protection and upside potential. Most investors also don't want to lose the
interest income from the convertible security.
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