Riskier Brand of CD Has a Foreign Flavor

Anyone who thinks that certificates of deposit are boring hasn’t seen the WorldCurrency CDs offered by Jacksonville, Fla.-based EverBank Financial Corp.

CDs are the essence of dull and risk-free investing: Buy a certificate for a set period and earn the fixed interest rate until it matures. But not EverBank’s CDs. These certificates, sold over the Internet to customers across the country, can soar in value one year and plunge the next -- much like the stock market or the value of the dollar.

“The difference between this and a traditional CD is that at the end of the term, you could lose money,” said Chuck Butler, president of EverBank World Markets. “You could also gain money, on top of the stated yields.”

What makes these CDs unusual is that they’re bets on the future value of the U.S. dollar. When investors put their money in EverBank’s currency CDs, they’re not investing in traditional bank deposits; they are instead entering the world of international money trading -- a market in which fortunes can be made or lost overnight.

In this case, the investor plops down an amount ranging from $2,500 to $20,000 and picks a foreign currency -- or blend of currencies -- to invest in. Default risk is low because the investment itself is in government debt -- the equivalent of U.S. Treasury bills -- issued by the target country.

Each CD has a stated rate of return, usually 1% to 7%. But the country’s debt must be purchased in that country’s currency, so EverBank also exchanges the depositor’s dollars for, say, yen or pesos. And the account earns interest in that country’s currency as well.

When the CD matures, EverBank converts the investor’s pesos, for example, back into dollars. The investor’s ultimate return will depend on both the interest rate earned and whether that country’s currency has gained or lost strength against the dollar.

If the currency the investor bought is comparatively stronger than the dollar when the investment is cashed in, the investor can win big. Butler said that because the U.S. dollar slipped against the New Zealand dollar during 2003 and 2004, for example, investors in EverBank’s New Zealand World Currency CDs were taking home returns of 25% to 26%.

But through the first half of this year, the U.S. dollar gained against the New Zealand dollar. Even after accounting for the 7% interest rate on the accounts, investors were losing about 2% to 3% on their money because of the currency fluctuation, he said.

Although EverBank’s CD accounts are protected by federal deposit insurance, that doesn’t prevent principal loss in this case. The insurance protects investors from losing the securities in their accounts in the event of a bank failure. It does not protect the rate of return -- or loss -- on the underlying investment, Butler said.

Predicting currency swings is a complex and inexact science, experts warn.

A country’s currency will rise or fall in value based on several factors, said Kurt Umbarger, vice president of T. Rowe Price Associates in Baltimore. They include the country’s debt, the interest rate the country is paying on the debt, the country’s economic growth, central bank policy, the government’s political stability, inflation rates and the relative attractiveness of investment opportunities around the world.

When American investors buy foreign currency, they not only have to weigh those factors for the government they’re buying, but they also have to balance the same factors for the U.S. government and guess which currency is going to be relatively stronger over their investment horizon.

“The foreign exchange market is a tough market for professionals,” said Peter Morici, professor of business at the University of Maryland. “This is not something that I recommend that ordinary investors do, because it’s difficult to ascertain the risk.”

That said, many investment experts recommend that U.S. investors place 10% to 20% of their investments in foreign markets.

The reason: Foreign stock and bond markets tend to move at a different pace from those in the U.S. When one market is up, the other -- especially after accounting for currency swings -- is likely to be down. Investment research indicates that this “lack of correlation” provides a great diversification strategy. By investing a relatively small amount in overseas markets, investors may boost their returns while keeping the overall value of their portfolio more stable, Umbarger said.

A more conventional way to get that overseas exposure is to buy international or global mutual funds, which invest in a wide range of stocks and bonds from all over the world. The advantage to this approach is that the investor doesn’t lose everything if one country’s economy goes down the tubes, Morici said. The investment is diversified in multiple industries, multiple countries and multiple currencies.

For those who want a currency bet that doesn’t hinge on just one country’s fortunes, EverBank offers a World Currency Index CD, which is invested in “a strategic selection of different currencies.” But Morici said that was still a riskier bet than an international mutual fund.

Whether investing in EverBank CDs or in international mutual funds, experts stress that investors be ready for risk.

“In our view, there are significant investment opportunities outside the U.S.,” Umbarger said. “But there are obviously risks and volatility as well.”

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Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For previous columns, visit latimes.com/kristof.

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Riding the greenback

How much can currency swings affect otherwise low-risk investing in government bonds? Here’s a look at a hypothetical $20,000 one-year CD that earns 5% denominated in British pounds. At the time the investment is made, it costs $1.60 to buy 1 pound.

*--* Conversion rate of U.S. dollars Investor Percentage per pound receives return return $1.80 $22,909.09 +14.54% 1.70 21,636.36 +8.18 1.60 20,363.63 +1.82 1.50 19,090.91 -4.55 1.40 17,818.18 -10.91

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Source: EverBank

Los Angeles Times