Dollar Savings vs Currency ETFs: Which Is Better?

Dollar Savings vs Currency ETFs: Which Is Better?

Holding foreign currency has become a mainstream investment strategy. Whether you want to hedge against domestic currency weakness, diversify your portfolio, or simply park cash in a stronger denomination, two popular options stand out: dollar savings accounts and currency ETFs. Each has its own set of advantages, costs, and tax considerations. This guide breaks down both options so you can make an informed decision.

What Is a Dollar Savings Account?

A dollar savings account is a bank deposit denominated in US dollars (or another foreign currency). Instead of holding your local currency, you convert funds into USD and deposit them in a foreign currency account at your bank.

How It Works

1. You convert your local currency to USD at your bank's exchange rate.
2. The USD is deposited into a foreign currency savings or demand deposit account.
3. You earn interest on the USD balance (typically lower than local currency rates).
4. When you withdraw, you convert back to your local currency at the prevailing rate.

Typical Costs

Cost Type	Typical Range
Exchange spread	1.0% – 2.5% per conversion
Account maintenance	$0 – $5/month
Interest rate (USD)	0.5% – 4.5% APY
Wire transfer fee	$15 – $45 per transfer

Banks generally apply a spread of 1–2.5% on each conversion. Since you convert twice (buying and selling), the round-trip cost can reach 3–5%. This is the single largest hidden cost of dollar savings accounts.

Advantages

• Simplicity: Easy to open at most commercial banks.
• Deposit insurance: Covered by government deposit insurance programs (FDIC in the US, KDIC in Korea, FSCS in the UK) up to applicable limits.
• No market risk beyond FX: Your principal in USD is guaranteed by the bank.
• Liquidity: Withdraw anytime (demand deposits) or at maturity (time deposits).

Disadvantages

• High conversion spreads: Banks charge significantly more than the interbank rate.
• Low interest rates: Foreign currency deposit rates are often lower than domestic rates.
• Double conversion cost: You pay the spread both when buying and selling.
• Limited currency options: Most banks offer only major currencies (USD, EUR, JPY, GBP).

What Is a Currency ETF?

A currency ETF (Exchange-Traded Fund) is a financial product traded on stock exchanges that tracks the performance of a specific currency or basket of currencies. Examples include Invesco DB US Dollar Index Bullish Fund (UUP), CurrencyShares Euro Trust (FXE), and WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU).

How It Works

1. You buy shares of the currency ETF through your brokerage account.
2. The ETF tracks a currency's value through futures contracts, forward contracts, or physical currency holdings.
3. Your returns mirror the currency's movement plus any interest earned on collateral.
4. You sell the ETF shares when you want to exit the position.

Typical Costs

Cost Type	Typical Range
Brokerage commission	$0 – $10 per trade
Expense ratio	0.20% – 0.75% annually
Bid-ask spread	0.03% – 0.15%
Tracking error	0.1% – 0.5% annually

Currency ETFs are significantly cheaper in terms of conversion costs. With many brokers now offering commission-free trading, the primary cost is the annual expense ratio, which typically ranges from 0.20% to 0.75%.

Advantages

• Low cost: Much cheaper than bank conversion spreads.
• Liquidity: Trade during market hours with tight bid-ask spreads.
• Variety: Access to dozens of currencies, including emerging markets.
• Transparency: Holdings and pricing are publicly disclosed daily.
• No minimum balance: Buy as little as one share (often $20–$30).

Disadvantages

• Market risk: ETF prices fluctuate throughout the day.
• Tracking error: ETF returns may not perfectly match the underlying currency.
• No deposit insurance: Your investment is not protected by deposit insurance.
• Complexity: Futures-based ETFs can have rollover costs and contango effects.
• Brokerage account required: You need a securities account, not just a bank account.

Head-to-Head Comparison

Factor	Dollar Savings	Currency ETF
Annual cost	3–5% (round-trip spread)	0.2–0.8% (expense ratio)
Interest/yield	0.5–4.5% APY	Varies (embedded in returns)
Deposit insurance	Yes (up to limits)	No
Minimum investment	$100–$1,000	Price of 1 share (~$20–$50)
Liquidity	Instant (demand) or locked (time)	During market hours
Currency options	5–8 major currencies	20+ currencies
Tax treatment	Interest income + FX gains	Capital gains + dividends
Complexity	Low	Medium

Tax Implications

Tax treatment differs significantly between the two options, and this can have a major impact on your after-tax returns.

Dollar Savings Tax Treatment

• Interest income: Taxed as ordinary income in most jurisdictions (15–40% depending on your tax bracket).
• FX gains: When you convert back to your local currency at a profit, the gain is typically taxed as income or capital gains.
• Withholding tax: Banks may withhold tax on interest automatically.

Currency ETF Tax Treatment

• Capital gains: Profits from selling ETF shares are taxed as capital gains. In the US, long-term rates (0–20%) apply if held over one year; short-term rates (10–37%) apply otherwise.
• Dividends: Some currency ETFs distribute income, taxed as ordinary income or qualified dividends.
• Futures-based ETFs: In the US, these may be subject to the 60/40 rule under Section 1256, where 60% of gains are taxed at long-term rates and 40% at short-term rates, regardless of holding period.

The 60/40 rule can be particularly advantageous for active traders, as it effectively caps the tax rate on short-term gains.

When Dollar Savings Make Sense

Dollar savings accounts are the better choice when:

• Safety is your priority: You want deposit insurance protection and cannot tolerate any principal risk.
• Short-term parking: You need to hold USD for a specific upcoming purchase (tuition, travel, property).
• Simplicity matters: You prefer a straightforward banking product without needing a brokerage account.
• Small amounts: For deposits under $1,000, the fixed costs of ETF trading may not justify the savings on spreads.

When Currency ETFs Make Sense

Currency ETFs are the better choice when:

• Cost efficiency matters: For larger amounts ($5,000+), the savings on conversion spreads are substantial.
• Active management: You want to trade in and out of currency positions based on market conditions.
• Diversification: You want exposure to multiple currencies, including emerging markets.
• Long-term holding: The low annual expense ratio makes ETFs more economical for positions held over months or years.
• Tax optimization: The 60/40 rule (for futures-based ETFs) can reduce your tax burden.

A Practical Example

Let's say you want to hold $10,000 in USD for one year.

Dollar Savings Scenario

• Conversion spread (buying): 1.5% = $150
• Interest earned (3.0% APY): $300
• Conversion spread (selling): 1.5% = $150
• Net return: $300 - $150 - $150 = $0 (break-even)

Currency ETF Scenario

• Brokerage commission: $0 (commission-free broker)
• Expense ratio (0.40%): $40
• Bid-ask spread (round-trip): $15
• Embedded interest return: ~$280
• Net return: $280 - $40 - $15 = $225

The difference is stark: the ETF option delivers $225 more in net returns on a $10,000 position, primarily because of the massive savings on conversion spreads.

Hybrid Strategy: The Best of Both Worlds

Many savvy investors use a hybrid approach:

1. Keep an emergency USD buffer in a dollar savings account (3–6 months of expected USD needs) for safety and instant access.
2. Use currency ETFs for larger, longer-term currency positions where cost efficiency matters most.
3. Use fintech platforms like Wise or Revolut for actual currency conversions when you need to spend USD, as they offer near-interbank rates.

Final Considerations

Before choosing either option, ask yourself:

• What is my time horizon? Short-term needs favor savings accounts; longer-term positions favor ETFs.
• How much am I investing? Larger amounts amplify the cost advantage of ETFs.
• Do I need deposit insurance? If capital protection is paramount, savings accounts win.
• Am I comfortable with a brokerage account? ETFs require a securities account and basic market knowledge.

Both dollar savings accounts and currency ETFs serve valid purposes in a foreign currency strategy. The key is matching the right tool to your specific financial situation and goals.

For real-time exchange rate comparisons and to calculate conversion costs, visit hwanyul.com to make more informed currency decisions.