When most people think of investments, they want three things: significant appreciation potential, current income and safety of principal. Neither stocks nor traditional bonds offer all three. Convertible bonds do, and it's a hard combination to beat.
The term "convertible bonds" may or may not be self-explanatory. First of all, convertible bonds are, indeed, bonds. So, they promise interest and principal as long as the issuer remains solvent. But they also allow holders to convert into shares if the stock has appreciated meaningfully.
Most studies pitting convertible bonds against stocks find that over extended periods, they have delivered competitive returns with substantially less risk. Offering principal protection, they are also less susceptible to panic selling during down stock markets.
Convertibles have performed nearly as well as stocks, and far better than traditional bonds, this year. Roughly speaking, convertible bonds currently pay interest rates of 2 percent to 3 percent and should offer between one-half to two-thirds of the underlying stock's upside.
(Read more: Using annuities in a retirement plan)