A brokered CD is a certificate of deposit, but the key word is “brokered”. Basically, it’s a regular CD – issued by a bank or credit union – but made available to invest in through an investment brokerage firm.
Brokered CDs have higher fees but also have benefits over regular CDs. These benefits include access to potentially higher rates, no prepayment penalties, and the ability to exceed the FDIC insurance level by saving at multiple banks.
What is a Brokered CD?
A brokered CD is just like one you would invest in through a bank or credit union. The main difference is that an investment broker can make CDs available from multiple banks and credit unions, offering you a choice of the highest interest rates and longer maturities. You can even spread your CD holdings across several issuers to achieve greater diversification.
Basically, the investment broker is acting as an intermediary with the CDs. This is similar to how brokers are intermediaries for stocks, bonds, mutual funds, exchange-traded funds, real estate investment trusts, and other investment securities.
They offer the advantage of being able to hold multiple investments in a single account.
Sometimes brokered CDs are newly issued by a bank or credit union. Other times, they’re offered on the secondary market. That means you can invest in a CD that has already been issued, and maybe several months or years into its term.
If you are unsure if CDs are for you, here is an article from Bankrate that explains the pros and cons of CDs.
Brokered CD Fees
Though brokered CDs offer many advantages over those purchased directly from banks and credit unions, one disadvantage is with fees. Banks and credit unions don’t charge fees for CDs they issue directly. However, brokerage firms typically charge at least a small fee when both buying and selling brokered CDs.
There’s a pretty wide range on broker fees, so it pays to shop.
For example, Ally Invest charges $24.95 per transaction on CDs. If you’re going to invest in CDs through Ally Invest, it should be with larger CDs which will lower the percentage of the transaction fee. For example, on a $10,000 CD, a commission of $24.95 will be the equivalent of paying a fee of 0.25%. But on a $1,000 CD it is cost-prohibitive at nearly 2.5% per trade. And remember you’ll need to pay the fee when you buy and sell the CD.
Charles Schwab lists it’s brokered CD fees cryptically as “Selling concession is included in the offering price”. They don’t give a definition of exactly what that means, but such arrangements typically involve either the broker taking a piece of the interest rate offered on the security or charging slightly more on the principal value of the CD.
Fidelity has the most uncomplicated fee structure on CDs. It has no fee on newly issued CDs, and just $1 per CD on the secondary market.
Brokered CD Advantages
Despite the fees charged on CDs by brokers, brokered CDs do offer certain advantages over purchasing them directly through banks and credit unions:
Brokered CDs offer diversification. You can purchase CDs from multiple banks and credit unions for the same brokerage account. There’s no need to hold CDs at multiple banks and credit unions, since you can hold an entire portfolio in a single brokerage account.
A wider variety of interest rates. When you buy CDs from local issuers, you are limited to the interest rates they offer. If your own personal bank pays low interest, you’ll be stuck. But since brokers offer CDs from multiple issuers, you’ll be able to take advantage of interest rates provided by CDs with higher interest rates. For example, while a local bank may pay only 0.25% for a one-year CD, you may find a brokered CD that pays 0.75% for the same term.
Exceeding the FDIC insurance level. Banks and credit unions are generally limited to $250,000 per depositor with FDIC insurance. But since brokered CDs involve multiple banks and credit unions, there’s theoretically no limit on how much FDIC insurance you’ll have. You may be able to have $1 million in CDs invested with a broker, with the entire amount FDIC insured because it’s spread across five different institutions.
Brokered CD terms are often longer than local institutions. Most local banks issue CDs in terms of no more than five years. But you may be able to get CDs for 10 or 20 years when they are brokered. In an environment of higher interest rates, you may want to lock in those rates for longer terms than you can get with locally issued CDs.
No prepayment penalty. Since brokered CDs can be sold before they mature, you’ll escape the prepayment penalty banks and credit unions charge for early withdrawals.
Creating a balanced portfolio. You may prefer the convenience of being able to hold your CDs with the same firm where the rest of your portfolio is parked. That will give you a better opportunity to achieve the portfolio allocation you want. For example, in a time of market volatility you may prefer holding CDs in your portfolio rather than bonds. Since they have guaranteed interest rates, FDIC insurance, and often shorter terms than bonds, they may be more secure investments.
Brokered CD Disadvantages
Despite the advantages brokered CDs offer, there are some disadvantages:
Fees. We’ve already covered the situation with several major brokers. As you can see, while it’s possible to purchase newly issued CDs commission-free, you will have to pay fees in most cases. Just as important, the fee may need to be paid both on purchase and sale.
Callable versus non-callable. Because they are brokered CDs, and also because they often have extended terms, the CD issuer may make the CDs callable. That means they can require early redemption of the CD, which most likely will happen in an environment of falling interest rates (this will give the issuer an opportunity to replace high-interest CDs with lower-paying CDs).
Market value declines. This is a potential problem with longer-term CDs, those with maturities greater than five years, and certainly 10 years or more. But if you’re holding a brokered CD and interest rates rise, you may lose some principal value if you sell the CD before maturity. This is unlike a CD purchased directly from a bank, that will charge you a prepayment penalty for early withdrawal but will return your full principal invested.
Interest is not technically compounded. If you’re familiar with how banks and credit unions advertise interest rates as “APY”, this has to do with compounding. A bank-issued CD may pay 0.47%, but pay an APY of 0.50% with compounding of interest. Brokered CDs typically pay interest directly to the holder. That removes the possibility of a compounding benefit.
Bank failure. Unfortunately, the banks issuing CDs with the highest interest rates are often the ones that are financially unsound. That’s precisely why they have to pay above market interest rates. Fortunately, your investment will be covered by FDIC insurance even if the bank does fail. But there’s often a delay in the settlement of the accounts after a bank failure. What’s more, while FDIC guarantees the principal value invested in the CD, they may not cover accrued interest.
When Brokered CDs Make Sense
Brokered CDs make the most sense for investors with larger portfolios. After all, since brokered CDs typically come with fees, your individual CD investments will need to be large enough to make transaction fees inconsequential.
Still another reason why they work best for larger investors is because you may be looking for more than the usual $250,000 in FDIC insurance coverage. By buying CDs through a broker, you can take advantage of the FDIC insurance by as many banks and credit unions as you buy CDs with. That means you can literally invest millions of dollars in CDs while enjoying FDIC insurance on the entire portfolio.
But even for smaller investors – or at least medium-size investors – the options to invest in brokered CDs have expanded in recent years. Many more brokers are offering brokered CDs, as well as a wider variety of other investment securities. In addition, fees have come down to a level that makes it more practical for smaller balance CD investments. You may even find that the interest rate being offered on certain CDs is high enough to more than offset the transaction fees charged by the brokerage firm.