How to buy foreign currency fixed deposits in Singapore

As part of my ongoing efforts in diversifying my investments and looking for higher yielding instruments, I started to invest in foreign currency fixed deposits with Maybank using iSavvy.

Fixed deposits (FD) vs. foreign currency fixed deposits (FCFD)
We all know what fixed deposits or time deposits are. These are monies we deposit with a bank for a fixed tenure (time period) for a fixed interest rate. Fixed deposits are relatively safe instruments as unless the banks collapse, your principal and interest are much safer compared to other investments such as stocks and shares (equities) or unit trusts (mutual funds).

In return for this relative safety, the returns or the interest earned from fixed deposits are very low. On average, they hover as low as 1% plus to 2% plus. There is always a risk-return tradeoff in investments. Generally, safer assets such as fixed deposits give you a lower return compared to stocks and shares, derivatives (options, futures), commodities etc.

However, there is a type of fixed deposit that can potentially give you a much higher interest than the 2% plus you are getting and that is the foreign currency fixed deposit. What is a foreign currency fixed deposit that you can place with a Singapore bank? A foreign currency fixed deposit (FCFD) is similar to a singapore dollar fixed deposit in that you are also depositing an amount with the bank for a fixed tenure and for a fixed interest rate. However, the difference is that this deposit is denominated in a foreign currency.

Risks of foreign currency fixed deposits (FCFD)
Depositing in a foreign currency fixed deposit is available at most of the banks in Singapore. However, this type of fixed deposit is inherently riskier than the Singapore dollar fixed deposits. This is because exchange rates can go up and down during the tenure of the deposit. This can potentially cause your deposit to lose value if at the end of your FCFD tenure, the foreign currency depreciates or loses it value compared to the Singapore dollar. Conversely, if the foreign currency appreciates or gains its value compared to the Singapore dollar, your deposit and interest earned could gain in value.

Let us take an example to illustrate this risk.

Assuming you place a Australian dollar fixed deposit of AUD 10,000 for 12 months at an interest rate of 5%.

Principal in Australian dollar: AUD 10,000
Principal in Singapore dollar (at SGD/AUD : 1.20) : SGD 12,000
Interest earned in AUD at end of 12 mths: AUD 500

If you had put that same amount of Singapore dollars for 12 mths at 2% interest,
Principal in Singapore dollar: SGD 12,000
Interest earned in Singapore dollar at the end of 12 mths: SGD 240.

Scenario 1: Assume Australian dollar strengthens or appreciates against Singapore dollar (SGD/AUD: 1.30)
Interest earned in Singapore dollar at end of 12 months at 1.30 : SGD 650 (AUD 500 x 1.3)
Principal converted back to Singapore dollar at end of 12 months at 1.3: SGD 13,000
Principal + Interest in Singapore dollar: SGD 13,650

Under scenario 1, congratulations, you have made a better return of SGD 410 (SGD 650-240) over your interest and a exchange gain of SGD 1,000 (SGD 13,000-12,000). So you end up with a total return of 13.75% on your intial deposit of SGD 12,000 in the Australian dollar fixed deposit.

Scenario 2: Assume Australian dollar weakens or depreciates against Singapore dollar (SGD/AUD: 1.10)
Interest earned in Singapore dollar at end of 12 months at 1.10 : SGD 550 (AUD 500 x 1.1)
Principal converted back to Singapore dollar at end of 12 months at 1.1: SGD 11,000
Principal + Interest in Singapore dollar: SGD 11,550.

Under scenario 2, you realise you have made a better return of SGD 310 (SGD 550-240) over your interest. HOWEVER, you have made an exchange LOSS of SGD 1,000 (SGD 11,000-12,000). Your principal + interest exchanged back to SGD gives you SGD 11,550 or a LOSS of SGD 450! Hence, instead of enjoying a return of at least 2% if you had deposited in Singapore dollar fixed deposit or even 5% if the Australian dollar didn't move against Singapore dollar, you made a loss of 3.75%!

Therein lies the risk of FCFDs. The volatility of exchange rates during the tenure (time period) of your foreign currency fixed deposits can cause the typically higher interest of 5% to 8% on currencies such as Australian dollar, New Zealand dollar to be offset by the loss in your principal when you exchange back your foreign currency deposit to Singapore dollar.

Why do people still deposit in FCFDs given the risk?
Many investors still put in their monies into such FCFDs despite the risk because they recognise this risk and are willing to accept the volatility in return for higher returns. Others take up risk mitigating strategies. One such strategy that I have adopted is to invest in FCFDs when the exchange rate is relatively favourable, i.e. when Singapore dollar is relatively strong or when the foreign currencies have weakened relative to Singapore dollar.

Another strategy is not to exchange back your principal. Because it is the risk of the exchange loss on your principal amounts in foreign currency that can potentially wipe out all your additional interest earned on your FCFD compared to Singapore dollar FD, what I did was to earmark my FCFD for long-term investment and allow it to auto-roll or auto-renew. What this means is that I am deferring the possible exchange losses/gains to a later date because so long as I do not exchange the currency back to Singapore dollar, I will not suffer a gain/loss.

However, this is not 100% foolproof because if in the long term Singapore dollar appreciates against the FCFD currency, then I will still be hit by exchange losses in the future.

The only true way to mitigate this risk is to use derivatives to hedge yourself against the risk but this is outside of my scope as a small investor.

Invest at your own risks
What I have shared are just a way that I have diversified my portfolio by putting aside a relatively small portion into higher yielding assets. Currently Maybank's iSavvy foreign currency fixed deposits for 6 months in NZ dollar yields about 8%. This is 4x the average 2% interest you can get from Singapore dollar fixed deposits. This is risky because the New Zealand dollar fluctuates against Singapore dollar and hence this is not guaranteed returns.

I am prepared to hold for the longer term and only exchange it back if I need the cash or when the exchange rates are favourable. Please do your own homework and consult with professionals about the risk before investing as this is very much more risky if you do not have holding power or if the Singapore dollar is on a sustained rally against major currencies.

Consider your own risk profile and decide for yourself if this type of investment is for you.

Be well and prosper.