Unsurprisingly, I’m getting a lot of emails from subscribers asking if they should sell off, buy the dip or make big changes to their portfolios.
It’s a scary time. War is raging in Ukraine, and the global situation feels like it could go from bad to worse at any moment.
So it’s normal that investors are looking to lower their risk.
There aren’t many great alternatives. If you sell your stocks and go to cash, you make next to nothing in interest while inflation gobbles up your savings.
And then if the market turns around, you’re sitting on the sidelines. And let’s be honest, most investors won’t get back in until prices are much higher because the recent drop is still fresh in their memory. Those wounds take awhile to heal.
History shows that, time and time again, investors get back in very late to the party after the market has already climbed considerably from the lows.
Fortunately, there’s a way to greatly reduce your risk without sacrificing the upside of a stock…
And the thing is, few advisors and no discount brokers ever talk about this investment. Neither does the financial media.
I’m talking about convertible bonds.
You may be thinking, “Convertible bonds? Sounds boring,” or “Sounds complicated.”
I don’t know about you, but a high degree of safety with chances of growing my money by several hundred percent is a combination I consider the opposite of boring. And it’s not as complex as you may think.
Convertible bonds are bonds that can convert into stock at the owner’s request.
Here’s why that’s exciting…
Bonds are safer than stocks. Much safer.
Stocks will rise and fall depending on the underlying company’s fundamentals, the overall market, the associated sector’s performance and other factors. When you want to sell the stock, if it’s higher than what you bought it for, you make money. If it’s lower, you lose money. If the company struggles, you could lose a lot of money.
The price of a bond also fluctuates, but it really doesn’t matter because when you buy a bond, it has a maturity date and you plan to own it until then. You can always sell it at a profit if you get the opportunity, but regardless of what happens to the bond’s price, at maturity, the bond pays you par value, which is $1,000.
So if you buy the bond for $1,000, you will get your $1,000 back at maturity, plus the interest you receive during the time you hold the bond. If you buy the bond for $900, you will receive $1,000 at maturity. If you pay $1,100, you’ll receive $1,000. This is why I recommend that you buy most bonds at $1,000 or lower, though there are exceptions.
The company’s earnings could stink and the CEO could be a dirtbag, but as long as the company doesn’t go bankrupt, you’ll get your $1,000 back, again collecting interest along the way.
Here’s where convertible bonds get interesting. With these unique securities, you get all of the safety of a bond that I just described – but at your request, you can convert the bond to a predetermined number of shares at a predetermined price.
Let’s say you paid $1,000 for a convertible bond that matures in December 2024, pays 4% annual interest and converts to 20 shares of stock at $50 a share.
And let’s say that the convertible bond’s associated stock is $40 today. With the stock at $40, you obviously wouldn’t convert the bond to stock because you could buy the stock in the open market for less than the $50 conversion price.
So instead, you’d hold the bond for the next year while collecting your 4% annual interest.
Fast-forward to March 2023. The stock is now trading at $100. You can convert your bond into 20 shares of stock. If you do, you would now own $2,000 worth of stock ($100 per share x 20 shares) for which you paid $1,000 when you bought the bond.
In the case of convertible bonds, the bond price typically moves in tandem with the share price. So even if you don’t convert to the stock, the bond price will be sharply higher because of the $100 stock price, so you could always sell the bond for a profit without converting.
On the other hand, if the stock never rises above $50, you can collect your 4% until maturity and get your $1,000 back.
You get all of the upside of stock with all of the safety of bonds. Convertible bonds are the perfect investment for uncertain times like these.
— Marc Lichtenfeld
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Source: Wealthy Retirement