Now investors have a new option available for diversifying outside the U.S. dollar: a foreign currency CD.
When the U.S. economy struggles, investors often consider turning to foreign markets. But many investors hesitate to participate in the forex market because of its inherent risk. One bank has come up with a way for investors to profit in foreign currencies, while eliminating some of the risk and complexity of the forex market (read more about about the Forex Invesment Market). Certificates of deposit (CD) in foreign currencies offer investors the option of profiting from the interest on the deposit and any gains on foreign currency conversion.
Investors have plenty of reasons to invest outside the U.S. right now (some of which were covered in our story, Why Investing Outside the U.S. Makes Sense Now). Between trade deficits, the credit crunch and the subprime mortgage fallout, the U.S. market is shaky. Investing in a foreign currency CD is a fairly simple way to diversify and hedge against a falling U.S. dollar, but the strategy is not without risk.
“The most important thing that [foreign currency CDs] are designed to do is to help an investor diversify their investment portfolios, so that not the whole investment portfolio is denominated in dollars,” Chuck Butler, president of the EverBank World Markets, said.
“There are times…when it’s a very good tactical investment to actually diversify yourself out of the dollar, to buy a currency that looks to perform well against the dollar. You could look to gain from that dollar’s move down,” Butler said.
EverBank’s World Markets division, located in St. Louis, is the only bank in the nation that offers FDIC-insured deposit accounts and CDs in a number of foreign currency CDs, according to EverBank’s website. It is worth noting that FDIC insurance covers loss because of bank failure but not currency fluctuations.
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EverBank’s products include single currency CDs and multi-currency CDs, such as the Viking CD, which holds money in a combination of Norwegian krones, Danish krones and Swedish kronas. EverBank also offers a DollarBull CD, which offers investors the option to borrow in a foreign currency and profit if the dollar appreciates against that currency. It is important to note that the interest rates offered on EverBank’s rate sheet are specific to the individual currencies.
“[Investors] see that we offer a New Zealand CD at 6.5 or 7 percent, or an Iceland CD at 9 percent, and their eyes immediately get big and they think they’re going to get that in dollars,” Butler said. “That interest rate is in the foreign currency, and…there is risk to your principal should the currency lose.”
However, foreign currency CDs carry a significant amount of risk. For example, if an investor has $20,000 invested in a one-year CD using the British pound (GBP), and one GBP is worth $2.03, that investor would get 9,852.22 GBP. When the CD matured, assuming a 4.5 percent interest rate, that investor would earn 443.35 GBP in interest, leaving that investor with 10,295.57 GBP. If the GBP increased in value such that 1 GBP equaled $2.08, that investor would receive $21,414.79—a profit of $1,414.79. However, if the GBP decreased in value to equal $1.98, that investor would receive $20,385.23—a profit of only $385.23. (All figures in this example were rounded up to the nearest cent.)
“Currency is no more risky to have in your portfolio than a stock,” Butler said. “You look at the currency as the stock of that country.”
Additionally, investors should be aware that even domestic CDs carry some amount of risk. If the U.S. dollar inflates or is devalued relative to other foreign currencies, import prices increase. Thus, even though CD holders don’t lose any money directly, the buying power of their money can certainly decrease.
Recently, currency appreciation rates have been more pronounced than in the example provided by EverBank. The Brazilian real, for example, has jumped 18 percent against the U.S. dollar this year, according to Forbes, and the Indian rupee has risen 12 percent since April, according to The Economic Times.
This is excellent news for anyone already invested in reals or rupees. However, should the dollar bounce back, investors in single or multi-currency CDs may lose money. Some investors have avoided the hype and stuck with a long-term foreign currency CD investment strategy.
“Because these trends in currencies are long trends—they normally average anywhere from seven to 10 years—we want people to be diversified for long periods of time, so we want them to have a long-term relationship with the currencies,” Butler said. “You can roll a CD every three months when it comes due. We have CDs on our books since 1995 that just keep rolling.”
For more information about EverBank’s foreign currency CD, including current rates, please visit their website.