Convertible securities can ease effects of volatility

If you're concerned about the effects of market volatility on your portfolio, what can you do? Actually, you can do a lot.

Diversify

To begin with, you can diversify. If you own only one type of investment, such as growth stocks, you'll expose yourself to a significant degree of risk. Why? Because when a particular set of market circumstances negatively affects growth stocks, you'll have nothing else to take up the slack.

But if you spread your investment dollars among a variety of asset classes growth stocks, growth-and-income stocks, bonds, money market accounts, government securities you will reduce the risk of a downturn hitting just one group.

Even within your diversified portfolio, you may want to consider some individual investments that have the potential of reducing the effects of volatility.

Convertible advantage

One such investment is a "convertible" security, which can be either a convertible bond or a preferred stock.

Like other fixed-income investments, a convertible security pays interest and principal payments. But there's also a key difference: If you own a convertible, you can turn it into shares of common stock in other words, you can convert it.

This unique feature gives convertibles some interesting advantages. First and foremost, convertibles share the relative stability of fixed-income investments while simultaneously being exposed to the potential gains of the underlying stock.

Convertible prices move in the same direction as the prices of the stocks into which they can be converted and yet the convertibles are generally less vola-tile.

Convertibles also give you a certain degree of investment flexibility, because you can make money in different ways. You can either sell your convertible when its price goes up in the market, or you can convert it to common stock and then either hold or sell the shares.

Your decision will depend on your individual situation and needs, but just having the choice gives you greater control over your investment picture.

Homework

Before buying a convertible, you'll want to do your homework. That means you'll need to determine the quality of the business issuing the bond. Is it a good, strong, stable company? Will it have any trouble paying you back your principal and interest payments? In addition, just as you would with stocks, look for the potential growth.

And here's something else to keep in mind: Although convertibles may be less volatile than their underlying stocks, that doesn't mean their price won't fluctuate. Also, a lot of convertibles are issued by more aggressive companies in turbulent sectors, such as technology and telecommunications.

So, even if the company that issues the bond is run well, has a good business plan and produces a solid product line, it still can be susceptible to the winds of change that blow over an entire industry.

Ultimately, convertibles are not the simplest investment you could choose. Before you buy one, you need to know exactly how it works, what your options are and what sort of company you're loaning money to.

But if you do your research carefully, you could find that the right convertibles could help smooth your drive through an unpredictable investment world.

(Betty J. Neal, CFP, is an investment representative with Edward Jones in Springfield.)