A foreign currency certificate of deposit (CD) is similar to an ordinary CD in that an investor can lock up funds for a period of time and earn a set interest rate. But with a foreign CD, the money is converted into another currency for the duration of the term; the funds earn interest in that currency, and the money is converted back to dollars at the maturity date.
Foreign currency CDs sometimes offer much higher returns than other types of CDs. However, they do come with some potential downsides and these CDs can be affected by volatility in the currency markets.
Here’s what you need to know about how foreign currency CDs work, their pros and cons, and how to start investing in them.
How Foreign Currency CDs Work
There are a number of ways to invest in foreign currency. How does a foreign currency CD work? An investor deposits their U.S. dollars in the CD account for a specified period of time known as the term (typically three months to five years). The dollars are then exchanged for a foreign currency or basket of currencies, and the money earns interest in that currency.
At the end of the term the total is converted back to U.S. dollars, and the investor receives their principal plus the interest — similar to an ordinary certificate of deposit.
Typically CD interest rates are somewhat higher than traditional interest-bearing savings or checking accounts, to compensate for the fact that the investor’s money is inaccessible for the term — and foreign currency CDs tend to have higher rates owing to the higher risk.
The longer the term of a foreign currency CD, the higher interest rate the investor earns.
Foreign currency CDs can be a way for investors to hedge against the risk of the U.S. dollar depreciating in value.
How You Can Make Money With Foreign Currency CDs
Returns earned on foreign currency CDs depend on the current interest rates in the country of the chosen currency. Every country has different interest rates, some of which are much higher than the U.S. rates. By investing in another country one may be able to earn those higher rates.
If the currency exchange rates work in the investor’s favor, the value of the CD could also increase – and they could see a higher return in addition to the interest gained.
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How You Can Lose Money With Foreign Currency CDs
Although there is an opportunity to earn high interest rates on foreign currency CDs, this type of CD is risky. Other types of CDs are known to be safe investments, so it’s important to understand the difference.
Currency markets have high volatility and are unpredictable, so the exchange rate between the U.S. dollar and the chosen currency may fluctuate a lot between the beginning and end of the CD term. If a foreign currency loses value compared to the U.S. dollar, an investor will lose money at the end of the term, and the interest gained may not be more than the loss. However, if a foreign currency rises in value compared to the U.S. dollar, investors will earn an even higher return than the interest alone.
The intricacies of currency markets are one reason why foreign currency CDs aren’t recommended for retail investors who don’t have the tools or experience to anticipate what might happen to any particular currency.
One catch to be aware of is that the countries that have the highest interest rates tend to have the most volatile currencies. So it can be tempting to invest to earn those higher rates, but there is a higher risk of loss as well.
How Risky Are Foreign Currency CDs?
Foreign currency CDs are fairly risky investments because currency markets can be quite volatile. For this reason, these CDs tend to be used by institutional investors more so than retail investors.
Investing in currencies requires an in-depth understanding of many different factors that can affect their values. Institutional investors often buy into foreign currency CDs if they know they have an upcoming payment to make in that currency. They can exchange the money and earn interest on it until it becomes time to make the payment.
How to Protect Your Investment
There are a few key ways to protect investments in foreign currency CDs.
Temper Currency Risk
One of the greatest risks in investing in foreign currency CDs is that global currencies can fluctuate a lot in a short amount of time. It can be tempting to buy into currencies that have the highest interest rates, but those are the most volatile and risky.
Instead, it’s better to choose stable currencies with lower interest rates, or invest in a basket of foreign currencies. It’s also recommended to only put a small amount of money into foreign currency CDs for portfolio diversification and exposure to foreign markets.
Look for FDIC Protection
The FDIC insures CDs up to $250,000, but this only applies to CDs opened with U.S. banks. Although an investor can buy into a CD from a foreign bank, it won’t be insured and will come with higher risk, so it’s best to look for foreign currency CDs backed by U.S. banks.
Another important fact to keep in mind is that FDIC won’t protect against currency fluctuations for foreign currency CDs.
Be Aware of Fees and Charges
All types of CDs tend to have early withdrawal fees, although there are some no penalty CDs. Foreign currency CDs also have conversion fees that are sometimes included in the price of the CD. Be sure to inquire about the cost of any foreign currency CD.
How to Open a Foreign Currency CD
Most U.S. banks don’t offer foreign currency CDs, so investors interested in buying into them will need to do some research to find them. Banks that do offer foreign currency CDs tend to offer multiple foreign currency choices. Some also offer CDs that have a group of foreign currencies in them to provide investors with broader exposure.
Investors can open foreign currency CDs with overseas banks, but they are not FDIC insured so they come with greater risks.
Banks offering foreign currency CDs sometimes require a certain minimum deposit amount, and there may be fees associated with currency exchange.
Other Ways to Invest in Foreign Currency
In additional foreign currency CDs, there are other ways investors can gain exposure to foreign currencies:
• Mutual funds
• Exchange-traded funds (ETFs) and leveraged ETFs
Investing in mutual funds and ETFs is just as easy as investing in stocks, and more CDs are becoming available to retail investors, so these are simple ways to buy into foreign currency markets. Forex trading is more complicated.
The Takeaway
Foreign currency certificates of deposit are one way investors can gain exposure to foreign markets. Although this type of CD can earn a higher interest rate than traditional CDs, they also come with a higher degree of risk. Global currency markets are complex and difficult to predict — often volatile — with the potential for higher returns but also steep losses for foreign currency CD holders. This type of savings option is recommended only for more experienced investors.
If you’re looking to open a checking or savings account, you might want to consider SoFi’s online banking app: an easy all-in-one account. You can open a Checking and Savings on your laptop or phone. There are no account fees, and if you use direct deposit you can earn a competitive APY. The online platform lets you set personal savings goals, and you can see all your financial information in one simple dashboard.
FAQ
Are foreign CDs FDIC insured?
If a foreign CD is purchased through a U.S. bank it will be FDIC insured, but if it is purchased through a foreign bank it is not.
Which US banks offer foreign currency accounts?
The most well known bank offering foreign currency CDs is TIAA bank, formerly known as Everbank.
Can US banks hold foreign currency?
Yes, U.S. banks can hold foreign currency.
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