A quick glance at the chart below is enough to give most investors a brilliant idea: "Why should I earn a measly quarter of a percent on my cash here in the United States when I can get fifty times as much interest by shifting my cash to Brazil?"
Continue Reading Below
The answer is simple: You can't get any more interest in Brazil than you can get here, there, or anywhere. Why? Because the MBAs who run international finance are smarter than you, and they have the system all set up to eliminate any advantage of simple interest rate arbitrage.
It works like this: To start earning interest in Brazil or anywhere else, you must transfer your money from your current legal tender, such as U.S. dollars, into the legal tender of the country where you want to start earning interest. That involves a foreign-currency transaction (commonly called "Forex," short for "foreign exchange").
Forex is a whole world unto itself, where experts steep themselves in local knowledge of various nations and work complex computations and algorithms intended to predict how one specific currency will move against another currency today, next week, next month, next year, five years out, and even farther. They're more savvy than the average investor, and they specialize in this kind of thinking. That's why it's so difficult to make any money in the forex markets.
So when you change your U.S. dollars to Brazilian reals or European euros or anything else, the exchange rate anticipates not only the current interest rate in that other country, but also how that currency is likely to move against your own.
Forex transactions in actionNow let's go through a typical transaction intended to reap the 14.25% interest rate available in Brazil.
You take $1,000 in U.S. dollars and exchange them for 3894.49 Brazilian Reals. Then you deposit that money in a Brazilian bank and earn 14.25% interest for six months. Now you have 4171.97 Brazilian Reals. That's good.
But you don't live in Brazil. You live in the good old U.S. of A. So to really enjoy that money, at some point you have to bring it back here. That requires you to exchange your 4171.97 Brazilian Reals for U.S. dollars. When you do that, you'll find that you get just about $1001.25, which is the precise amount you would have earned if you had left your U.S. dollars in a U.S. bank at U.S interest rates.
This is a concept called "interest rate parity."
In the real world, however, you pay a commission to exchange dollars for reals and then reals for dollars, so for all your trouble you're likely to wind up with less than parity.
Of course, you could get lucky and do your exchanges during an interval when the MBAs are wrong. If major political, economic, military, environmental, or social events wreak havoc on expected rates of foreign exchange before you bring your money back home, you could reap a big windfall -- or a major loss, if unexpected events go the wrong way for you.
In any case, these simple transactions are unlikely to lead to major profits unless you're way smarter than the experts -- or just plain lucky.
So what's an investor to do?
Your first step should be to check your portfolio's asset allocation to make sure you're not keeping more in cash than is wise. When your asset allocation is right, you'll have the maximum amount possible invested in your favored opportunities.
After that, it's important to use your cash wisely, keeping only what you really need in short-term demand accounts while the rest of your cash works harder for you in higher-earning vehicles.
The article Don't Bother Putting Cash in Other Countries originally appeared on Fool.com.
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.