Foreign Currency CDs: What You Need to Know
Understanding the Pros and Cons of Investing in Foreign Currency
With interest rates still historically quite low by historical standards, you may find yourself on a quest to find ways to get more income from your cash savings.
Foreign currency CDs can offer yields that double traditional CDs in the U.S., but it’s important to understand their potential pros and cons, and how they are impacted by the volatility of currency markets. It’s also crucial to pay attention to other investments that may offer similar or even better returns with less risk.
Foreign Currency CD Basics
Placing money in foreign currency CDs is simple, in theory. Your U.S. dollars are converted to a foreign currency and then exchanged back to dollars when the CD matures. Just like traditional CDs, your money is tied up for a specific term with a fixed interest rate; the longer the term, the better the rate.
In practice, finding U.S. banks that offer foreign CDs is not easy. Most banks don’t offer them, but TIAA Bank is one popular place to get them. They offer CDs with most major currencies, as well as “CD baskets” offering exposure to six currencies in one investment.
With TIAA Bank, there is a minimum deposit of $10,000 to access their WorldCurrency CDs, and the bank will charge as much as 1 percent for currency conversion.
It’s possible to purchase foreign currency CDs by going to banks overseas, but then you lose the protection of the Federal Deposit Insurance Corporation, which protects account holders in case a bank becomes insolvent.
How You Can Make (and Lose) Money With Foreign Currencies
With foreign currency CDs, income is based on the prevailing interest rates in the country you select. For this reason, returns can be quite higher in that CDs tied American dollars. Interest rates in Mexico, for example, were close to 8 percent as of November 2018.
Investing in foreign currency CDs comes with risk, however, due to the volatility of currency values. The exchange rate between the U.S. dollar and other currencies may differ drastically from the time you open a CD and the time it matures.
Let’s say you decide to deposit $10,000 into a foreign currency CD tied to the British Pound. With an exchange rate of 0.77, you place 7,700 pounds into the CD with a term of two years and an interest rate of 2.5 percent. The interest may earn you about 400 pounds, for a total of 8,100 pounds. Now, let’s say the British Pound declines in value against the dollar during that time, and now you need 0.90 British Pounds to get a dollar. This means you’ll have just $9,000 after the currency is exchanged.
On the flipside, if the British Pound were to gain value, you might make money. Let’s assume the same above scenario, but with the pound’s value rising so that only 0.60 pounds would be needed to get a dollar. An investor would be left with $13,500 after currency is exchanged.
It’s important to understand, however, that it is extraordinarily hard for average investors to predict how currencies will rise or fall.
It’s easy to fall into a trap when chasing after higher yields; those nations with higher interest rates often are those with the most volatile currencies.
Other Ways to Invest in Foreign Currencies
If you are thinking about investing in foreign currencies but want to reduce your risk, you can purchase mutual funds and exchange-traded funds. In this way, you can gain exposure to currencies by trading shares of ETFs or funds just like stocks.
While there is debate about whether these investments are appropriate for retail investors, there has been a growth of these products available through discount brokerages. Fidelity, for instance, offers foreign currency ETFs tied to most major currencies. There are also leveraged ETFs that allow you to borrow funds and amplify your returns (or losses) on currencies, as well as inverse currency ETFs that allow you to profit if a currency falls.
Foreign currency investments of this kind should not make up the bulk of a person’s investment portfolio due to their volatility and unpredictability. In fact, most retail investors should probably avoid them altogether.