In a recent article about the importance of diversification, CBS MoneyWatch noted that 22 percent of the stocks in existence during the 1990s had negative returns – and that doesn’t include stocks of companies that went bust during that decade. This kind of data stresses just how important diversifying between investment vehicles is for all investors.
When investing in securities, you have many different options that can help you distribute your risk more effectively. You can choose to invest in equity securities, such as shares of stock; you can choose to invest in debt securities, such as bonds; or you can select what’s called a hybrid security. Hybrid securities are investments that have attributes of both equity and debt securities.
Example of a Hybrid Security
The easiest example of a hybrid security is found in a convertible bond. In general, bonds are considered debt securities because they are loans given to companies or municipalities that promise to pay back the principal along with interest over time. A convertible bond is one that can be transferred into shares of a company’s stock. Once it is converted, the shares of stock (which represent equity in the company) take the place of the principal repayment expected at maturity and the growth in the market value of the shares of stock replaces the bond’s coupon rate.
A convertible bond maintains the traits of a hybrid security as long as it is in bond format and offers the potential to be converted to an equity. Once a convertible bond is converted into stocks, it is no longer a hybrid security.
The Benefits of Hybrid Securities
Hybrid securities offer investors some flexibility in capitalizing on market fluctuation. In the example above, we discussed convertible bonds. Sticking with this example, you can see where the convertible bond, when it remains in bond form, helps insulate the investor from fluctuations in the market by providing a fixed interest (or coupon) rate. However, should the investor see the market value of the bond-issuing company’s stock rising, they can take advantage of this movement and convert the bond.
While hybrid securities offer a flexible way to diversify your retirement and investment accounts, they are not the only tool that should be in your investing toolbox. Give us a call or stop by to see how we can help you with all your investing needs.