Foreign currency CDs can offer yields that double traditional CDs in the U.S. Still, 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 than foreign CDs.
How Foreign CDs Work
Placing money in foreign CDs is simple, at least in theory. Your U.S. dollars are converted to a foreign currency, placed in a CD, and then exchanged back to dollars when the CD matures. Just like traditional CDs, foreign CDs tie up your money for a specific term length with a fixed interest rate. Typically, 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. TIAA Bank offers CDs with most major currencies, as well as “CD baskets.” providing 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% for currency conversion.
How You Can Make (and Lose) Money With Foreign Currency CDs
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 than in CDs tied to American dollars. Interest rates in South Africa, for example, were close to 5% as of 2020. 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%. The interest may earn you about 400 pounds, so you finish with 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. Your 8,100 pounds are now worth just $9,000 (8,100 divided by 0.90 = 9,000). Instead of gaining money, you’ve lost $1,000 of your original $10,000. On the other hand, 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 the currency is exchanged (8,100 divided by 0.60 = 13,500). 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 foreign currencies by trading shares of ETFs or funds just like you would with 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, lets you buy foreign currency ETFs that are 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.
