Understanding Brokered Certificates of Deposit (CDs): A Comprehensive Guide

I explained in my last blog post that Certificate of Deposit (CD) is a kind of savings account offered by banks. While credit unions generally offer a similar product called Share Certificate, some state-chartered credit unions offer CDs as well. CDs are low-risk deposit accounts that allow your money to grow at a fixed rate over a fixed period or term. Traditionally, you invest in CDs directly with the banks issuing them. Another way to buy CD is through a brokerage firm. This is called a Brokered CD.

A brokered CD is the CD you buy from a brokerage firm rather than directly from a bank. They are issued by banks, but the brokerage firm buys them in large quantities and sells them in smaller units to investors. Therefore, brokered CDs have higher interest rates compared to traditional CDs. Since brokered CDs are issued by banks, they are covered by the Federal Deposit Insurance Corporation (FDIC). If the bank that issued the CD fails, your money is insured up to $250,000.

The differences between traditional CDs and brokered CDs include:

o    Traditional CDs are bought directly from the bank while brokered CDs are bought through a broker.

o    Traditional CDs must be held until their maturity. Otherwise, an Early Withdrawal Penalty may be incurred. Meanwhile, brokered CD may be sold before maturity without a penalty. However, there may be an associated transaction commission.

Brokered CDs typically have minimum investment and increment, both of which are usually $1000. However, some brokerage firms offer fractional CDs making it possible to invest as little as $100 in CDs. This comes with some restrictions. For instance, if you need to sell your CD before  it matures, you may be required to sell the entire fractional CD you hold.

Brokered CDs can be a new or secondary issue. New issues are bought when a bank issues them while secondary issues are the CDs that are traded in the market before their maturation. These could be sold above or below par value. If the interest rate has gone up since the initial purchase, the CD loses value in the secondary market, and it may be sold at a loss or there may not be a buyer for it.

Advantages of Brokered CDs

o   Flexibility: In terms of duration and issuer, brokered CDs are more flexible. Brokered CDs can have more flexible terms than traditional CDs. For example, some brokered CDs have uncommon terms that are rarely available with traditional CDs, like one month, 13 months, 60 months  and other terms.

o   Ability to diversify and expand FDIC coverage: Brokered CDs also make it possible to compare and/or buy CDs issued by multiple banks at the same places without having to go to each bank’s website. You may also diversify by investing in multiple CDs through the same broker. Having all CDs in one place makes them easier to manage and allows for expanded FDIC insurance beyond the limit of $250,000 per individual per bank.

Disadvantages of brokered CDs

o   CDs may be callable: This means the CD can be called (terminated) by the issuer before maturity. This usually happens when the interest rate goes down. It allows banks to stop paying customers higher interest rates than the current interest rate. When a CD is called, the issuing bank will pay the interest accrued till the call date in addition to the principal. If you still need to invest your funds, you may have to reinvest at a lower interest rate. To avoid this scenario, you may only invest in call-protected brokered CDs.

o   Fees: While there are usually no fees associated with new issue CD purchase, some brokerage firms may charge fees to buy and sell CDs in the secondary market.

o   Lack of compounding: Unlike traditional CDs that are typically compounded (interests are added to the principal and can also earn interest), brokered CDs earn simple interest. The interest is added to your account but only the principle can earn interest.

How to buy Brokered CD

o   Open a brokerage account: In selecting a brokerage firm, you want to do your due diligence by checking the reputation and the reviews of the brokerage firm you are interested in.  If you already use a brokerage firm for trading stocks or cryptos or one that manages your retirement account, you may want to use the same one. As a result, you will have all your investments in one place, and you can easily manage them. Some reputable brokerage firms where you can explore brokered CDs include Fidelity, Vanguard, Charles Schwab and Robinhood.

o   Decide whether you want to buy a new issue CD or secondary issue: If you plan to buy secondary issues of brokered CDs, you may also want to consider the fees and commission when selecting a brokerage firm.

o   Determine the term of the CD: Brokered CDs generally offer a wide range of terms and the interest rate for each term may be different. Determine the term and interest rate that aligns with your investment goals.

o   Research the bank that issued the CD: Make sure the bank is financially stable, and it is backed by FDIC

o   Determine if CD ladder works for you: CD ladder involves investing in multiple CDs with staggered maturity date. As each CD matures, you may cash out or reinvest your money. If reinvesting, it may be beneficial to set a rollover option when investing in the CD. When a CD rolls over, you have a grace period to terminate the CD if you don’t like the terms of the new CD.

Summary

Brokered CDs provide stability and a reliable way to grow your savings over time. They offer more flexible terms, and they let you invest in CDs of multiple banks in the same brokerage account, ultimately expanding the FDIC coverage. In choosing a CD, it is important to research both the brokerage firms and the issuing banks.