Financial products like foreign currency Certificates of Deposit can diversify your portfolio with foreign currency, but bear certain risks. EverBank, an established online bank, has taken the lead in developing these foreign currency products and they now offer FDIC Insured certificates of deposit that can be purchased in US dollars and track foreign currencies ranging from the Euro, to the Brazilian Real and the Indian Rupee. EverBank has also offered baskets of foreign currency CDs, where you can structure your CD to be divided among a handful of currencies, and a Dollar Bull CD, that might increase in value faster as the dollar rises against select foreign currencies. FDIC insurance for these products protects investors from a bank failure; it does not protect against currency fluctuations and the resulting loss of value in dollar terms.

How foreign currency CDs work:

1. You deposit your money.

2. They convert your funds into the currency of your choice.

3. They deposit your funds into an FDIC insured Certificate of Deposit.

4. At maturity the funds (the principal, interest, and currency changes) are converted back into dollars and can be withdrawn.

5. Or, the funds can be rolled over into another term CD.

How You Can Benefit from Foreign Currency CDs

• Interest. Like any Certificate of Deposit, depositors benefit from the interest paid on the invested amount. Depending on the currency, these rates can be quite high and can be higher than the equivalent rate of return in US dollars.
• Currency Movements. As the currencies you invest in rise and fall against the dollar, you can make or lose money. For example, if you invest in the Euro, and it strengthens 5% against the dollar during the term of the CD, you will have made an extra 5% on your investment. If it loses 5% against the dollar, you will have lost 5%.

If your goal is to track the performance of a certain currency and believe that currency will appreciate, but may be concerned about the risks to the banking system in that country, these products may make sense as they can extend US FDIC insurance where it may not otherwise be available.

If your goal is to outperform the US rate of return through getting a rate of return above that which may be available through a standard US-based CD, you may do better to look at a structured product issued by a US investment bank. Some US investment banks, for example, now offer collared products which will yield 10% if the Brazilian real appreciates against the dollar, but only 1% if it depreciates.

A Word of Caution

Use only US-based FDIC-insured banks. Foreign currency CDs offered by non-US FDIC insured banks and marketed through the internet at US citizens are SCAMS, even if they appear in Google, Yahoo! or Bing search results. The CD that is offering an incredible rate of return by investing in some currency or in US dollars in some bank that isn't FDIC insured in some country that you have never heard of sounds too good to be true because it is. Don't send your money there.

Banks generally issue large blocks of CDs to brokerages, who then break the blocks up to re-sell to their customers. Since the brokerages purchase the CDs in large blocks, they may be able to negotiate higher rates than an individual customer can get from a bank. The brokerages generally re-sell the CDs to their customers without fees.

Brokerages re-sell these CDs without fees because they want to keep their clients money within the brokerage. When the CD expires, the money is still with them, and can be re-invested in stocks, bonds, or another product that they offer.

A Brokerage CD is usually FDIC insured by the original issuing bank.

For consumers, a brokerage CD offers the following benefits:

• Convenience. The convenience of buying more than $100,000 in CDs from one location and keeping all of the money FDIC insured. A consumer could buy three $100,000 CDs from three different banks using one brokerage. Because the CDs were originated from three different banks, the full amount would be FDIC insured. These CDs are then housed in one place and not at three separate banks.

• Potentially Higher Rates. Brokerage CDs generally pay above market rates because the brokerages have negotiating power with the banks

• Liquidity. Brokerage CDs may be able to be resold before their maturity date (instead of redeemed), allowing you to withdraw your money without penalty. Depending on current interest rates, your CD may be worth more or less than what you paid for it. .

In addition to the advantages, we saw one huge disadvantage to brokered CDs in 2008, 2009 and 2010 as many banks went under and were acquired by other banks through FDIC-managed sales or transformations. CDs purchased directly with banks like IndyMac or Wachovia were transferred to CDs with the same terms from the acquiring / resulting institution. However, brokered CDs were ordinarily paid out on the date the bank ceased to exist. As we were in a falling interest rate environment, proceeds from brokered CDs could not be readily invested at the same rate.

In addition, brokerages often offer more exotic CD products. Below are some of the different types of CDs offered by brokerages:

Callable CD

Callable CDs usually offer a higher rate of interest because the issuer reserves the right to buy them back at some point in the future. For example, if interest rates drop, the issuing bank may decide that it can borrow money for less than it is paying on some of its CDs, and it may buy back those CDs. Most callable CDs come with at least a year of call protection.

If you want to lock your money in for a certain period of time, and believe interest rates are going to rise in the future, these may be good bets. You are effectively "selling" the call feature in return for which you will receive a higher rate of return.

Zero Coupon CD

Zero Coupon CDs do not pay interest over the term of the CD or have a coupon. Instead, you buy the CD for discount over its face value and when it matures you get the full face value. So, you might buy a 5-year, $20,000 CD for $15,000 and when the CD matures you would get the full $20,000.

The biggest disadvantage to so-called Zeros is that the income is taxed annually by the IRS. So you will need to pay taxes on the income you are earning without receiving the income until the maturity date. Zeros therefore are most effective when held in a tax-exempt account.

Secondaries

These are CDs that you can purchase from others on the secondary market. The prices of these CDs depend on the direction of interest rates, the credit worthiness of the issuing bank, and other competitive products.

Selling a Brokerage CD

If you plan on buying Brokerage CDs with the intent of selling them, then you should consider several factors.

1) What do you think will happen with interest rates? If interest rates drop, the value of your CD will drop with it.

2) The credit worthiness of the issuing bank. A large percentage of secondary market brokerage CDs are purchased by large institutions who only want CDs issued from highly rates banks, regardless of whether they are FDIC insured.

3) Ask the broker to check the value of similar issues on the secondary market.

In general, as with all cash equivalent investments, be sure to run the numbers and take into account the other benefits and drawbacks of the investment before making a decision. You should also talk to a certified investing professional who can help you evaluate your choices.

Like dollar cost averaging into an equity security, you can reduce reduce the risk of adverse interest rate changes by dividing your intended CD investment into multiple CDs coming due over various time frames, instead of buying a single CD.

The basic premise of CD laddering is to always have a CD that is coming due in 1 year.

Non-Laddered CD Investing

Suppose you have $100,000 to invest. If you were to have invested this entire amount in 2006 in one year CDs, your returns would look something like the following:

As you can see, the return starts off okay but at the end of the fifth year (2011), interest rates drop and you're stuck investing at 1.2%

CD Laddering

Had you broken the $100,000 into 5 different investments and placed $20,000 each in different term CDs (ranging from say six months to five years), you would have suffered significantly less from the low interest rates in 2010 and 2011, and presumably you would still have some of your money earning higher interest from the longer term CDs.

What laddering does do is smooth out your earnings potential. If rates are high today but drop precipitously in one year you will still have some higher yield, longer term CDs in your portfolio to boost your earnings. Effectively, laddering cushions a portfolio from the steep drop in rates like the one that we have recently seen. Laddering, of course, becomes less effective if rates remain low for an extended period as all of your CDs of various durations will roll over into lower rate replacements.

In some years the laddered approach does better and in other years the non-laddered approach wins. In an extended low-rate environment like today, a laddered approach may be the best way to go. The laddered approach allows investors to earn a better yield on longer-term CDs while still keeping some money relatively liquid in shorter-term CDs should rates begin to rise. Keeping all of your money in shorter duration CDs is better when you are sure interest rates are going to rise, or rates have already begun to go up. Keeping all of your money in longer-term CDs is prudent if you expect rates to plunge, as they did starting in 2008. But, since most of us are not prescient enough to forecast the direction of rates, laddering provides a safe alternative that doesn't require a crystal ball.

Another advantage of laddering is that money comes due every year. Investors that may need the cash at some point, have access to a portion of it every year without having to break a CD and incurring any resulting penalties.

Designing a CD Ladder Today

If one wanted to design a hypothetical CD ladder today, here's how it might look. To get the best rate, we'll use CD rate data provided by BestCashCow. I've looked at both local banks and credit unions (I live near Boston) and online banks to get the best rates for each term. Although this requires a bit of driving around, I've made sure using BestCashCow data that all of the banks have branches relatively close to where I live - within 4 miles.

Investment amount of $100,000

This is the best portfolio I could build. The rates are terribly low and I'm not happy about locking money away for 5 years at 2.40% APY but for all we know, rates might be even lower in five years. After all, in 2008, everyone expected hyper-inflation and soaring rates while the exact opposite has happened. If rates do go up, I can reinvest the money that comes due from the one and two year CDs.

To begin building your CD ladder, spend some time investigating the best CD rates. Get the best rates you can from local banks and credit unions and online banks and then ladder away.