Overseas Government Bonds Tempt U.S. Buyers

By Bankrate.com


Continue Reading Below


Take Ireland and Greece. The yields on their 10-year government bonds reached a sky-high 9% and 11% in February, respectively. But with the generous returns come more risk than investors realize.



Credit Risk a Big Gamble






Currency Fluctuations Pose Risk


"Instead of getting the touted 7% or 8% you end up getting 3% or 4%," Richelson says.

The Foreign Politics Wild Card

Currency risk is exacerbated when countries in financial trouble choose to deliberately devalue their currency. But currency devaluation is only one way countries put foreign investors at the mercy of that country's political system, Richelson says.

Foreign governments can choose to raise taxes on foreign bondholders, place restrictions on how bonds can be bought and sold or simply decide to stop bond payments they still can afford to make, she says.

Stan Richelson, co-author with his wife, Hildy Richelson, of "Bonds: The Unbeaten Path to Secure Investment Growth," cites Brazil as an example. It limits the amount of Brazilian government bonds that foreign investors can sell in a given period. While those limits may help stabilize the country's economy, they also reduce flexibility for U.S. investors who elect to invest in the country.

Grealish agrees that the sometimes-capricious behavior of foreign governments can create problems for bondholders. "The real risk to bondholders is that the government might change the rules," he says.

All this risk means foreign sovereign debt performs more like equities than like investment-grade U.S. bonds, says Hildy Richelson.

If you're determined to search for higher yields outside the U.S., the Richelsons suggest Yankee bonds, which are bonds issued by foreign governments and corporations but denominated in U.S. dollars.

Yankee bonds cut out the currency risk associated with investing in foreign debt, although the credit risk and political risk remain, Hildy Richelson says.

Foreign Deposits Not Much Safer

In a world where the average yield on a one-year certificate of deposit is less than 0.5%, searching the globe for a better deal on your deposits might seem like a smart play. Deposit accounts in foreign countries often can garner higher interest rates than U.S. deposits, but such accounts carry many of the same risks of foreign government bonds.

Grealish remembers a time in the 1980s when many American savers sought higher savings yields in Mexican bank accounts. The result?

"The Mexican government went and devalued the currency, and (American savers) lost a ton of money," Grealish says. "If you're strictly looking at savings accounts -- investing in the currency to get that higher rate of return -- you've got to ask yourself, 'What is this going to be worth when I convert it back into dollars?'"

What do you think?

Click the button below to comment on this article.