The Best of Both

If variety is the spice of life, diversification is the spice of the mutual fund arena. If it's spice you want, you may consider a convertible securities fund.

"Convertible securities are hybrids-they have some characteristics of bonds and some of common stocks," says Joseph Brennan, a principal in Vanguard's Portfolio Review Group who leads a team of analysts that oversees more than 130 mutual funds, including the popular Vanguard Convertible Securities Fund(VCVSX). Like bonds, convertibles typically pay a fixed rate of interest and repay principal on a given date in the future. And, Brennan says, "they typically pay an income yield higher than the dividend yield of the issuer's common stock but lower than the yield of the issuer's bonds." You'll find between 75 and 100 securities in the broadly diversified Vanguard Convertible Securities Fund, the majority of them convertible bonds.

Companies bringing convertibles to market are usually mid- and small-cap companies that may have low to medium credit ratings. But convertibles have their benefits: They are good diversifiers, and they play a balanced and defensive role in a portfolio.

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Bottom line: Convertible funds are income producers that Brennan says are "unlikely to outperform in a bullish stock market or fall far behind in a bearish one."