How to Invest in Convertible Bonds

Convertible bonds can be converted to a set amount of the issuer's common stock.

Convertible bonds are hybrid securities that exhibit return properties of both bonds and stocks. Convertible bonds can be converted to a set amount of the issuer's common stock. Individual convertible bonds should be purchased through a broker that has a bond desk that specializes in the convertible markets. The do-it-yourself investor has the best opportunity for convertible investing through closed end funds--CEFs.

Instructions

1. Apply for and fund an online broker account if you do not have one. Make sure the money you want to invest in convertible bonds is in the account or make a deposit. According to the Smart Money magazine 2010 Broker Survey, the top rated online brokers are Fidelity, E-Trade and TD Ameritrade.

2. Research the available convertible closed end funds for yield, return and management fees. The Closed End Fund Association--CEFA--database shows 11 CEFs under the convertible securities category. The three largest CEFs in the convertible category are:

   Calamos Convertible Opportunities & Income Fund, symbol CHI.
   Nicholas-Applegate Convertible & Income Fund, symbol NCV.
   Advent Claymore Convertible Securities & Income Fund, symbol AVK.

3. Select the convertible CEFs that meet your investment criteria and decide how much to invest in each one. The CEFA database provides detailed information on each fund. One opportunity with CEFs is to buy shares trading at a discount to their net asset value--NAV. Use the historic discount and premium to NAV to help you narrow your fund selection.

4. Buy the selected convertible security closed-end fund shares through the stock trading screen of your online brokerage account. You must enter the stock symbol and number of whole shares you wish to purchase.

Tips & Warnings

• The convertible securities CEFs have dividend yields of 5 to 12 percent. These dividends will be deposited in your brokerage account when they are paid.

• The majority of convertible bonds are issued by companies with lower investment grades. These securities do very well in a strong economy and have trouble in a economic recession.

• Don't base your investment decisions on past performance. Review a fund's investment objectives and expenses before selecting where to invest.

• Convertible bond prices are influenced by both the bond and stock market trends. It is possible to lose some of your investment in these securities. Do your own research and understand the risk before making any investment decision.

References

• CEFA: Convertible Security Closed End Funds
• Investopedia: Convertible Bond