Dateline: Kuala Lumpur, Malaysia
I am constantly amused by what passes as an “alternative investment” or even an exotic investment in the western world today.
Just a few weeks ago, I wrote about all of the positive developments for entrepreneurs and investors in the Eurasian country of Georgia, only to receive a number of emails saying “what the heck is over there?”
Most US persons and other westerners view buying gold as an “alternative investment” or even as the ultimate portfolio diversification.
For me, true diversification is much more complicated and involves many more angles than the western financial media wants you to believe:
1. Sector diversification – The most common type of diversification, this involves investing in a variety of industries, even more so than most westerners are familiar with
2. Jurisdictional diversification – Diversifying your money across different countries to reduce your sovereign risk and the potential for government wealth confiscation or even high taxes
3. Geographic and geopolitical diversification – Diversifying into economies at different growth stages as well as economies with higher risk-reward due to potential geopolitical issues
And last but not least…
4. Currency diversification – Diversifying out of your home currency and into other fiat currencies. Buying precious metals could be included in this category or others.
Most US persons in particular are particularly deficient in currency diversification as they only deal in US dollars. They buy stocks and mutual funds in US dollars, own real estate denominated in US dollars, and they have a local banker could likely never even imagine how a bank account could hold more than one currency.
Even some who follow our advice here to diversify internationally go to destinations like Panama where the US dollar is a de facto currency for valuing assets, giving them jurisdictional and some geographic diversification, but no escape from the threats associated with US dollars.
That’s why many Americans have looked at US bank foreign currency CDs as a way to diversify. This special type of certificate of deposit have been promoted rather heavily at times not so much as a way to diversify, but with a sexier sales pitch…
…a way to make more money.
Several US banks offer foreign currency CDs that denominate the value of your deposit in a currency or currencies other than US dollars. Everbank is perhaps the biggest proponent of the foreign currency CD and has a variety of options.
The idea is simple: “broader diversification, less portfolio volatility and new gains”, says one bank. Usually for as little as $2,500, you can move your own cash or money held in an IRA into one of these CDs.
Are foreign currency CDs insured by the government? Sure. While the account itself is FDIC insured (little consolation, in my opinion), you are of course not protected from currency fluctuations.
The better question is, “are gains from currency fluctuations taxable by the IRS?” Again, the answer is yes.
Let’s consider a scenario: if you opened a Russian ruble currency CD, you’d have lost half of your money in dollar terms the same way everyone who has an account at Sberbank lost half of theirs.
I remember a financial advisor in the US once telling me he felt banks had an unfair advantage in selling investment products because people naturally believed banks were safer and came with government insurance… even when they sold uninsured investments.
In the same way, people who don’t know much about foreign currencies could be lured into thinking that a foreign currency CD is a “no lose” proposition because it’s offered by a bank.
The fact that banks tend to market profit potential rather than an escape from holding only US dollars speaks to the fact that their customers probably aren’t extremely savvy global investors.
The fact that one bank crows that “interest rates are available” – implying the truth that the US dollar is such a mess that holding it doesn’t even pay any interest – suggests its depositors are merely seeking any escape they can from a near zero yield currency.
The problem is, they’re going about it all wrong.
Foreign currency CDs may offer the much ballyhooed FDIC insurance on deposits, but they also come with the threats involved with sitting in the United States.
Since a lot of western countries have been using everything from “pension reform” to “bail-ins” to confiscate private wealth lately, a foreign currency CD misses a chief benefit that comes with international diversification: the international part.
Swiss francs or Australian dollars sitting in a US bank account may sound sophisticated to someone who doesn’t even have PIN-and-chip in their “first world” debit card, but there is really nothing very international about it.
It’s just a bank engaging in a currency trade. You lose all of the benefits of jurisdictional diversification.
You also lose the very thing the banks use to promote these products: money.
While the marketing pitch for holding foreign currencies is “higher rates”, many of the foreign currency CDs I’ve seen actually pay 0%. That includes those denominated in euros, Swiss francs, British pounds, Czech koruna, and Singapore dollars.
I already earn at least 1% or very close to it on all of those currencies (save for the koruna) held in offshore bank accounts. While 1% is hardly anything to write home about, it’s infinitely better than zero.
If I wanted to hold those currencies outside of highly stable banks in highly stable countries, I could do that, too. Heck, the aforementioned Georgia pays 4.5-5% on US dollar CDs.
And it shows that the purveyors of these CDs are taking quite a premium for their allegedly exotic offering.
Similarly, Australian dollar accounts in the US don’t crack 1%, whereas any bank in Sydney will pay you closer to 4% for the same one-year term deposit.
Ditto for New Zealand dollars.
I must admit that I was rather impressed by the 11.5% APY on a three-month Russian ruble-denominated CD when you compare it to deposit rates in Russia. Except for the fact that, well, it’s a CD denominated in rubles.
While I’m all for Jim Rogers’ idea of investing in Russia on the belief that it’s a battered economy that has been overly vilified, but investing in the currencies of these nations is often not the road to riches that a more active investment is.
That’s why no one in emerging markets does it. I spent time in Turkey last month, where locals all scoffed at the 9.5% APYs on one-year CDs, preferring much higher returns in real estate.
The point is that you can do much better when it comes to rates, sophistication, and service by holding foreign currencies in an offshore bank account. One log-in to a Hong Kong or Singapore bank’s online banking and you’ll wonder how the third world US banks even survive with such shoddy offerings.
If you want to hold Singapore dollars, get on a plane and go to Singapore to open an account. I’ve consistently been hearing from clients that my bank recommendations for both entry-level and private banking customers are accurate and easy to use.
In exchange for paying one visit to a foreign bank to open an account, you’ll enjoy almost all of the diversification benefits listed above as well as typically higher rates.
You’ll also enjoy institutional diversification, and since banks in places like Singapore, Germany, and even Australia tend to be the safest in the world – much safer than US banks – you’ll have your money in an institution that doesn’t have to offer gimmicky products to stay in business.
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