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Foreign-currency CDs: Tempting but risky

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Foreign-currency CDs can be awfully tempting for savers chasing higher yields. These certificates of deposit can offer mouthwatering rates of 6% or more.

But be aware that they’re pegged to foreign currencies that can slip and slide unexpectedly. As you consider making foreign-currency CDs part of your portfolio, understand the risks and rewards.

How they work

Foreign-currency CDs can be issued in euros, Indian rupees, South African rands or Brazilian reals, to give a few examples. The CDs are exchanged for dollars so a U.S. buyer can invest. They are converted back to dollars when the CD matures.

However, there are currency exchange risks when you make the conversion back to greenbacks. A strengthening dollar can wipe out your return.

“That’s a big impact. And the currency markets have become more volatile,” says Walid Petiri, president of Financial Management Strategies in Baltimore.

Given the risks, Petiri says investors shouldn’t consider foreign-currency CDs as safe as traditional CDs. Instead, he says think of them as “enhanced fixed-income replacements,” because you can get higher total returns than regular CDs.

RATE SEARCH: Compare CD rates on Bankrate.

Not for the risk-averse

Still, there are solid benefits for investors who can stomach the risk. If a foreign currency spikes against the dollar, you’ll nab a higher total return than on traditional CDs. And that higher rate also is guaranteed.

Foreign-currency CDs also are readily available. You can buy them via overseas or U.S.-based banks.

Foreign-currency CDs help diversify your investment portfolio, says Chuck Butler, managing director of EverBank Global Markets. “These CDs provide a hedge if the dollar depreciates,” he says.

Another benefit is that Americans with overseas obligations can buy CDs timed to their payments, Butler says.

Jeff Sica, president and chief investment officer at Sica Wealth Management in Morristown, New Jersey, says investors in foreign-currency CDs must grasp what will make a particular currency strong, including an understanding of complicated government policies that affect currency fluctuations. That means scrutinizing a country’s monetary policies.

“Foreign-currency CDs are the worst investments for novice investors,” Sica says, explaining that they could be “annihilated” when the foreign currency sinks in relation to the dollar.

Protecting your investment

To protect your investment, make sure you follow these three rules.

  1. Temper currency risk. Global currencies can fluctuate wildly in a short time span. So EverBank’s Butler says these CDs are geared toward buy-and-hold investors. The twist is that CDs in highly volatile foreign currencies usually pay the highest interest rates.

    But Sica says if you buy the highest-interest foreign-currency CDs, you’ll risk a greater likelihood of declines. “Don’t be a yield chaser,” he says. “It’s a recipe for disaster.”

    Instead, he recommends investing in lower-volatility currencies such as the Swiss franc, or in a CD basket, which is an assortment of currencies. And invest minimally — no more than 5% of your portfolio.

    When investing in foreign-currency CDs, know the full story. “Have low expectations and be very diligent at knowing your risk tolerance,” Sica says.

  2. Look for Federal Deposit Insurance Corp. protection. Foreign-currency CDs issued by U.S. banks are backed by the FDIC. But if you buy a CD overseas, you forgo that protection. That’s why Sica advises investors to stick with foreign-currency CDs sold in the U.S.

    But keep in mind that the FDIC doesn’t protect your investment from currency fluctuations if you incur losses.

  3. Be aware of fees and other charges. Petiri, of Financial Management Strategies, says fees can be embedded in the CD price. For example, some banks charge a fee to convert a foreign-currency CD back into dollars. And, if you withdraw your money early, you could be assessed other fees and suffer a loss of interest. Currency losses are taken against any interest

“The interest rate is the enticer, but look at the currency volatility and know the value that you’re getting.” Petiri says.

RATE SEARCH: Compare CD products on Bankrate.