Mitigating the Risks of Investing in Foreign Currency Fixed Deposits
The risk of foreign currency fixed deposit is the risk that the foreign currency you invest in loses its value (or depreciates) against Singapore Dollar. That can potentially wipe out the higher interest you earn from putting your money there. Therein lies the potential risk, and therein also lies the potential returns as well.
I was fortunate in investing in my first foreign currency fixed deposit (FCFD) just after the sharp correction in New Zealand Dollar (NZD) and managed to lock in at NZD/SGD 1.07 at a rate of 8.4%. I was lucky in that now NZD has risen against SGD to about NZD/SGD 1.12 or +4.67%. This could have easily been reverse (i.e. -4.67%) if the US Federal Reserve had not cut the Feds fund rate thereby contributing to investors seeking better returns from higher yielding currencies such as NZD or Australian dollar (AUD).
Mitigating against foreign exchange loss risk of foreign currency fixed deposits
However, you can mitigate the risk of the foreign currency depreciating by considering the few options:
- Rollover of both principal and interest
- Rollover principal but collect interest
- Invest in foreign currencies whose economies are strong
Rollover of both principal and interest
Foreign exchange rates rise and fall over a period of time, if you have holding power, you can theoretically roll over your forex fixed deposit indefinitely or until the exchange rate is favourable to mitigate the risk of exchange losses wiping out the additional interest you get from investing in higher yielding currencies.
Rollover of principal but collect interest
Because the main risk of foreign exchange loss is due to the principal amount, you can reduce this risk by leaving your principal in the foreign currency (roll-over of principal). This helps you mitigate the loss because if your foreign currency interest is high e.g. NZD at 8%, SGD has to appreciate by more than 6% for you to be better off to have left your money invested in a Singapore dollar fixed deposit.
Invest in foreign currencies whose economies are strong
While we cannot predict exchange rates, we can see underlying themes e.g. NZD and Australian economies are doing okay as they benefit from the minerals boom created by demand by growing economies of China/India. Inflation is also rising in those countries and hence there is a higher chance of their central banks raising rates rather than cutting rates, as compared to US where many feel that the US Federal Reserve will likely cut rates in Nov 07, thereby weakening the USD further.
Foreign currency fixed deposits are with risks, and hence you should not be putting 100% of your investible savings but the current interest rates ranging from 4-8% interest for deposits is 2 to 4 times what you can get from an equivalent SGD time deposit.
You have to decide if the risk-return trade-off is worth it.
Be well and prosper.
