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Foreign currency investment: A case study (mine) on investing in India

Who doesn’t like a 10% return on investment?

Late last year we made the riskiest investment decision – we added foreign currency investments to our portfolio. We invested in India. Our investment vehicle is quite simple and easy for everyone to understand, Certificate of deposit. The risk comes from the fact that we converted from US dollars to Indian rupees and then invested the money in Certificate of Deposit.

I do not know how to make this post interesting. I tried; believe me. In the end I decided I will follow my usual style and give as much information as possible to make it easy for people who are interested in investing in India. For others, to get a general overview, skip to the cliff notes version.

Investing in India – How it works?

There are different ways to invest in India. Some people invest in the mutual funds or ETFs that focus on India (as far as I know, foreign investors cannot directly trade on the Indian stock exchange). A few invest in companies and have decision making capabilities. Some people won’t even know they are already invested in India (if you have certain emerging market mutual funds, you might already own a few Indian companies). For Indian citizens who are residing outside of India there are a lot more options to invest including regular savings account, foreign currency certificate of deposit and regular certificate of deposit.

Note: This post explains the options to invest in India available either to everyone or Indian citizens residing outside of India. I do not have much knowledge of all the options available for Indian citizens residing in India.

Opportunities to invest in India (available to everyone)

  • Investing in mutual funds or ETFs focusing on India: There are several funds/ETFs traded on NYSE/NASDAQ that are focused on India. Example: iShares S&P India Nifty 50 Index (INDY) or WisdomTree India Earnings (EPI).
  • Direct investing: I am not entirely sure how this works; I only know it is a possibility. What I understand is that, anyone investing directly will be funding part of a company and take part in their day to day decision making/management process.
  • Savings accounts: This is like any US savings account. You will have to convert the USD into Indian rupees before putting it in a savings account. Just like the FDIC insurance in the US, the amount in a savings account is insured by the Reserve Bank of India.
  • Regular certificate of deposits: The certificate of deposit concept is the same as well, you commit to keeping the money for a certain period of time, and in return you receive a higher interest rate than a savings account. Before opening a regular certificate of deposit account, you will have to convert the USD to Indian rupees and once the CD term ends, to bring the money back to US, you have again convert the Indian rupees back to USD. If the conversion rate goes in the wrong direction, you might lose your principal (see the risks section of this post below). The current rate for a 1 yr. CD is 9.8%
  • Foreign currency certificate of deposits: In my opinion this is the best option of the lot for the totally risk averse, because I don’t see any risk at all. The name is a little confusing, but in this case the “foreign currency” in the name refers to a foreign currency relative to India. For example, you can choose to open an account in USD or Euros. The money will be kept in USD or Euros, no conversion needed at any time. The rates are not as high as the regular certificate of deposit (current rate for a 1 yr. CD is 3%) but it is much better than the US rates. This is where we have part of our emergency funds. In essence, it is just like any US certificate of deposit with a much better interest rate.
  • Trading in Indian stock market: The Bombay Stock Exchange (BSE) is the 10th largest stock exchange in the world by market cap. The other Indian stock exchange, National Stock Exchange of India (NSE) follows closely in the 11th position. Any Indian citizen or Non-Resident Indian (NRI) can trade freely in the Indian stock exchanges. Some of my friends who bought shares of IT companies in the early 2000s are now several times richer due to the IT boom in India.

Opportunities to invest in India (available to Indian citizens residing elsewhere, also called as NRIs, Non Resident Indians or for any Indian descendants)

Currently our investment consists of two vehicles – foreign currency certificate of deposit (this is where part of our emergency fund is) and regular certificate of deposit (we have part of our retirement money here).

If major parts of the investing options are not available to foreign citizens, what is the point of this post? I was aiming to target two sets of people (1) Nonresident Indians who are looking to diversify their portfolio. (2) People who are immigrants (or descendants of immigrants) from other countries where similar opportunities exists.

Investing in other foreign currencies

United States of America is said to be built by immigrants. Most people in this country have ancestors from all over the world. So even if you personally do not hold a citizenship in other countries you might still be eligible to take advantage of a lot of the options available to the citizens just because your ancestors were citizens of the country. Or your spouse is an immigrant/descendant of an immigrant. For example, the investing options I described for India are not only available to current citizens but also for the 2nd generation down the line. All you have to do is show some proof that your ancestors came from that country and start investing!

I know at least a few more countries that have savings and certificate of deposit rates that will put the US rate to shame (A friend of mine holds a few Australian CDs that pays ~5% interest rate, I hear New Zealand has a high rate too). If you are willing to take the risks (read below to know the risks involved), it can be a very lucrative investment option. All you have to do look at your family tree and start digging which country offers the best investment.

Rewards for foreign currency investments

Before we get to bad news (risks), let’s hear the good news first. Why even bother with investigating and investing in other countries? Have you seen the interest rates in the US recently? Though it is good for us in terms of our mortgage, our savings are earning an abysmal rate, which brings us to the main reward –

High interest rates: Currently my regular certificate of deposit is earning 9.8% interest. Can you beat that with any investment in the US? Even my foreign currency certificate of deposit, which is in USD, just residing in India is earning a 3% interest.

Guarantee return: As it is a certificate of deposit, the rate of return is guaranteed for the term.

Risks of foreign currency investments

If there are no risks, everyone will be doing it and getting rich! There are substantial risks in any foreign currency investments.

It is foreign currency: However high the rate is and whether the rate is guaranteed or not, we are dealing with foreign currency here. The conversion rate can go up or down at any time and the repercussions are drastic. Let me explain  with an example.

Initial principal amount in USD: $10,000

At the date of initial conversion, let’s say the USD ($) to Indian Rupee (Rs.) conversion rate is $1 = Rs.50

Initial principal amount in foreign currency:  Rs.500,000

Now one of these three scenarios can play out

  Scenario #1 Indian currency collapses (or USD becomes too valuable) Scenario #2 Everything remains the same, the conversion rate stays the same Scenario #3 Indian currency becomes too valuable (or USD collapses)
Initial principal (in USD) $10,000 $10,000 $10,000
Conversion rate (1 USD) Rs.50 Rs.50 Rs.50
Initial principal (in foreign currency) Rs.500,000 Rs.500,000 Rs.500,000
Interest (1 yr. @ 9.8%) Rs.49,000 Rs.49,000 Rs.49,000
End of the term value (in foreign currency) Rs.549,000 Rs.549,000 Rs.549,000
Conversion rate (1 USD) Rs.75 Rs.50 Rs.25
End of the term value in USD to convert back $7320 (#lose) $10,980 (#win) $21960 (#superwin)

 

So I will lose a lot more than interest  if the foreign currency collapses. This is the main risk in any foreign currency transaction. No one knows exactly which direction the conversion rate will go.

Economy of that country: This is not a risk by itself, but if the economy of the country collapses, so will the currency, which in turn will eat up the principal.

Political climate of that country: Same deal as economy, if there is political unrest, the economy will be unstable and the currency will go down the drain.

What about other fees? When I started reading about this type of investment, I kept running into an argument that the fees will kill the deal. The following is a list of possible fees –

  • Wire transfer fee: I didn’t have this fee because I paid by check and chose to wait 3 weeks for them to get the cash. I lost 3 weeks of interest, but I was getting 0.9% interest and the 3 weeks loss of interest was less than a dollar.
  • Currency conversion fee: I had a flat fee commission rate of Rs.1000 (~$20); not much in the grand scheme of things.
  • Intermediary currency conversion commission: If you are paying a middleman to convert one currency to another currency you might pay another layer of commission. I didn’t, so I don’t know how much this would be.
  • Origin bank fee: I hear some banks charge a fee if their check is cashed in another country. Another reason to love my bank, Charles Schwab, they didn’t charge anything!
  • Another wire transfer fee: If I want the money immediately, I will have to shell out for a wire transfer fee when I bring the money back to the US. At this point the plan is to use the cheapest possible method, so hopefully I can avoid the wire transfer fee again.
  • Income tax on the interest: Whether I invest in India or Antarctica, Uncle Sam wants his cut. Don’t forget to include the foreign income in your tax return.

In my case, the fees were not large enough to be a deal breaker.

How are we planning to mitigate the risks of investing in India?

The first and foremost thing is we understand the risks. We know we could lose our principal and we are willing to take that risk. We invested only enough to not shake our entire financial foundation if the investment goes south. In other words, we invested only what we are willing to lose.

We can wait for 30 years or longer to see how it all unfolds. This is not our short term investment; we have part of our retirement money in foreign currency, which means we are looking at a very long term for things to work out.

Next thing I am trying to do is keep up with current events to better understand the country. As I grew up in India, I do understand the economy and politics a little better than any other country.  Ever since we got the idea to look into investing in India options, I have been paying a lot more attention to how things are going in my homeland. Usually I don’t pay attention to the budget presentation, but this year I sat and read through the entire budget presented by the Finance Minister a couple of weeks ago. These days I read every article I come across on the growth potential and the economy of India.

I have also studied the conversion rate over the last 20 years. I have to note that India is a fast growing economy, so the rate 20 years ago  is hardly relevant but it gives me a general idea on how major events (like Y2K problem or the dot com bubble) affected the conversion rate.

Based on my calculation, if the conversion rate was Rs.50 when I invested the money, it has to go up to at least Rs.54.90 for me to start losing the principal. My CD has a penalty of 3 months interest rate if I want to break it before the term ends. So if I keep an eye on the USD to INR rates and sense that it is going in the wrong direction, I can always break the CD and cut my losses.

Finally, if everything else fails, I do have a Plan B – leave the money in India. If Indian currency loses value, the only thing that will be affected is the ability to convert it back to USD. Whatever value I have in Indian rupees will still have the same value in India. We are planning to name a couple of Indian charities as the beneficiaries in our estate planning. We will simply plan it in such way that the money that was invested in India stayed in India and became the portion of our estate that was bestowed to the Indian charities.

Cliff notes version of foreign currency investments (or Investing in India)

  • If you are willing to take some risks, you can expand you portfolio by looking into other countries where there a lot of lucrative investment options.
  • In a lot of cases you don’t have to be a citizen of the country to take advantage of these options. If any of your ancestors came from the country you might able to enjoy the same investment options as a “person of [country] origin”.
  • Know all the fees and penalties.
  • Know what your risk tolerance level is. If it is low, invest only what you are willing/afford to lose.
  • Understand all the risks before investing. This goes for any investments.

I am not saying this is the best get rich quick investment. We know our risks and made an educated decision. I just wanted to show an example of how we are taking advantage of one of the options available to us in diversifying our portfolio. The takeaway message I want to drive down is – look beyond the traditional options to see what you might be eligible for and keep your portfolio diversified.

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