Dip Your Toes Into Stocks With Bonds

Convertible bonds pay interest but can also grow like stocks.

When stocks are unsteady, convertible bonds can be a refuge. Converts are securities with traits of both bonds and stocks. The idea is to earn some of the appreciation when the company's stock price rises but also to defend your principal when the stock falls. Converts have proven their worth in lean years. On average, the Merrill Lynch All U.S. Convertible Bonds index beat Standard & Poor's 500-stock index by a total of 14 percentage points during the 2000Ð02 bear market.

Technically, converts are a type of bond; there's a fixed-interest coupon and maturity date. So if you don't sell and the firm doesn't default, you're guaranteed to recoup the face value eventually. The main difference between a convertible and a regular bond is that you can exchange a convert for a set number of shares of the common stock. For that reason, if a company's stock rises, its converts become more valuable. If the stock lags, well, you're still a bondholder and will get some interest income, although it'll be less than what you would have collected with a standard bond. Convertible bonds today yield an average of 2.5%.

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Elizabeth Leary
Contributing Editor, Kiplinger's Personal Finance
Elizabeth Leary (née Ody) first joined Kiplinger in 2006 as a reporter, and has held various positions on staff and as a contributor in the years since. Her writing has also appeared in Barron's, BloombergBusinessweek, The Washington Post and other outlets.