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Foreign Exchange (FOREX) Currency CDs

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Euro CurrencyThere’s been a lot of talk in the last year about the US dollar being replaced as a reserve currency, in part because of all the bailouts and “quantitative easing” done to jump-start our economy. With all the recent economic forums, such as the G20 in Pittsburgh, it’s no surprise that this has been a topic of conversation.

So, we started looking at ways to diversify ourselves off the US dollar. It’s possible that the dollar could be replaced as a reserve currency but more importantly, we realized that in the increasingly global economy, it’s dangerous to have all your money be from one country. There’s a reason why gold spiked to over $1,000 an ounce and it’s because people wanted stability.

However, if you don’t want to own gold, are there other options? I think a foreign exchange currency CD might be a good idea. Before we make any decisions, we should do some research about them in the first place. I’m going to use Everbank as an example because I already have a banking relationship with them and their website offers up a lot of good information about their products. For our review I’ll use the MarketSafe BRIC Certificate of Deposit as the example.

Why a Forex CD?

The idea behind foreign exchange, or Forex, is that you get to trade you dollars for some other currency. When the exchange rate changes, you either gain money or lose money. The name of the game is trying to figure out the trends and buy other currencies when the dollar is worth more and sell them back when the dollar is worth less. If you were to get into it you would find it’s a little more complicated, but that’s the gist.

Why a Forex CD? You get to dabble in foreign exchange currency trading without actually getting involved in any exchanging of foreign currency. More importantly, with this MarketSafe CD, you get to dabble in forex without putting any principal at risk. You get exposure to the Brazilian real, Russian ruble, Indian rupee, and the Chinese renminbi currencies in the form of a three-year CD.

If you think the value of the dollar will fall relative to this basket of four currencies in three years, then you’ll want to deposit money into the CD. If you don’t think it will, then you won’t. It’s as simple as that.

What is the Risk?

There is no risk that you would ever lose your principal with a MarketSafe CD but that doesn’t mean you don’t assume any risk. Inflation risk is the biggest problem you have to deal with. Let’s say the dollar increases in value relative to the BRIC currencies, then you would earn 0% over three years. That doesn’t sound bad right? Well, inflation, despite being 0.19% this last year, probably won’t be 0%. Inflation would make your dollars, having been locked up for three years, worth less and less each year. This risk exists for any investment… if you aren’t moving forward, you’re moving backwards.

Anytime you invest your money, you want to compare your investment against a safe return. You have to decide whether you are getting enough in anticipated return to take on the risk you assume with that investment. A three year (36-month) certificate of deposit currently yields somewhere between 2.50% – 2.80% APY, as of September 2009. Your principal is protected in the MarketSafe CD but your anticipated return has to at least beat your 100% safe alternative investment. If you were to earn 0%, you’ve actually lost 2.80% plus whatever inflation took out the back door.

Next Steps

For now we’re going to pass on the CD as we do some more research in the space. I’m always hesitant to lock up anything for such a long time but a little bit of money might not be a bad idea just to get a little exposure. Do you have any experience in Forex or Forex CDs? Or have you been looking at ways to diversify outside the US? Any and all directions you can point me in would be very helpful!

(Photo: pingu1963)

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9 Responses to “Foreign Exchange (FOREX) Currency CDs”

  1. Hey, you know what they say about gold. It’s a wonderful conductor of electricity.

    So if that jewelry thing ever stops working, at least it has industrials uses to fall back on :)

  2. zapeta says:

    I read an interesting article yesterday about the dollar being replaced with a basket of currencies. Its from one of the bloggers at Time Magazine:
    http://curiouscapitalist.blogs.time.com/2009/10/06/what-if-oil-werent-priced-in-dollars/

    Anyway, they mention several positive and negative effects of the US Dollar being replaced as a reserve currency. It it something that could happen and a FOREX CD might be a way to mitigate some of the risk without risking the investment principal.

    I’m not an investment expert and definitely not a FOREX expert, but wouldn’t increasing your exposure to international companies in your asset allocation also reduce some of the risk since these companies would be operating with different currencies?

  3. Juan says:

    Hi,
    If you want to assume some risk I would consider buying the following securities in a brokerage account:

    World Inflation Protected securities ETF (WIP)
    PowerShares Emerging Mkts Sovereign Debt (PCY)
    WisdomTree Dreyfus Emerging Currency (CEW)

  4. reinkefj says:

    You can take a vacation and bring back some Euros. Actually hold the physical currency. As long as inflation is low, you’re forgoing a small amount of interest. But, if we get to hyperinflation, that will be trivial.

    With the congresscritters spending like there is no tomorrow, I still like gold bullion coins.

  5. Neil says:

    “If you were to earn 0%, you’ve actually lost 2.80% plus whatever inflation took out the back door.”

    Poor choice of words here, since it’s not true. You haven’t lost 2.8% annually plus inflation – you’ve lost 2.8%/annum exactly. The “safe” investment returns 2.8% whether inflation is 0% or 30%. Or a Weimar style 3,000,000% for that matter. So inflation is an outside parameter in comparing the two. Inflation is only a factor when comparing to either an inflation-indexed investment (like a real return bond), or to spending the money today.

  6. dilbert69 says:

    It’s a bit misleading to say that you’re not putting your principal at risk. Sure, you can’t lose any of the foreign currency you put into the CD (investment risk), but each unit of foreign currency could buy more or fewer units of your home currency than it did at the beginning of the investment (currency risk). That’s not to say that you should avoid foreign currency investments, only that you should be aware that there are two types of risk with them, and one of them (currency risk) simply cannot be avoided.

    • Neil says:

      Although this is poorly explained, the CD that is discussed is actually denominated, and principle protected, in US dollars. The investments made inside the CD are designed to track the basket of foreign currencies, but the lowest possible return, measured in nominal US dollars, is 0%.

  7. eric says:

    If it were one year, I would think about it but 3 years is a long time to lock the money–especially in FOREX CDs that are a bit more complicated.

  8. Vic says:

    Looks like you can’t bail out of the CD early and take a 6month interest hit since it’s variable.

    “Except in the event of death or adjudication of incompetence of the holder of the MarketSafe CD, you may not withdraw any part of the CD prior to maturity. If you do withdraw early, even if that is due to the death or adjudicated incompetency of the holder of the CD, you will NOT receive Principal Protection and will NOT benefit from any upside potential of the Reference Index, experiencing a loss of principal as an early withdrawal charge. Consult the Product Term Sheet and MarketSafe Terms and Conditions for details.”

    So it looks like if you pull out early, you’re not guaranteed the principal amount AND if there have been any losses you’re on the hook. Not to mention an early termination charge


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