Brokered CDs: What Are They and How Do They Work? – CNET

If you’re looking to supercharge your savings without risking your hard-earned cash, a brokered certificate of deposit may be the jolt your financial portfolio needs during these times of high inflation. Available for purchase through a brokerage firm rather than a bank, a brokered CD combines the benefits of a traditional CD but with a longer term and a higher yield. A 1-year brokered CD from Vanguard, for example, offers a 4.15% annual percentage yield, or APY, compared with 2.90% APY from the top yielding CD on CNET’s list of top 1-year CDs.

What is a brokered CD?

A brokered CD stems from a collection of CDs issued by banks or credit unions and sold in bulk to brokerages and investment firms. The investments are then resold to investors on a secondary market, similar to the way bonds are issued and sold. That’s why brokered CDs have higher APYs than traditional CDs — buying power. “Since the broker invests a large sum, it tends to generate more interest than multiple smaller amounts. While you may invest $10,000 in a CD, a broker may have 100 clients, all investing $10,000, so the banks are more likely to offer a higher yield since the broker is bringing in so much business,”  Baruch Silvermann, CEO of The Smart Investor, told CNET.

Individual investors use brokered CDs as a safe vehicle to park their cash while outperforming traditional savings accounts. A brokered CD is federally insured provided that the issuing bank is covered by either the Federal Deposit Insurance Corporation (FDIC), or issuing credit union is covered by the National Credit Union Administration (NCUA). But that’s not always the case as some brokered CDs stem from CDs that are issued by banks that aren’t federally insured. Coverage can vary, so investors should review the underlying CDs in a brokered CD.

How does a brokered CD work?

1. A brokered CD is purchased through a brokerage firm rather than directly through a bank. Brokers set a minimum investment amount, usually $1,000. Funds can be added to a brokered CD in any amount but usually in increments of $1,000. To purchase a brokered CD, you’ll need an account with a broker or investment firm. According to the Securities and Exchange Commission, however, deposit brokers are neither licensed nor regulated by a federal or state agency. Anyone can operate as a broker, so it’s important to conduct business with a well-researched and trustworthy agency or registered broker.
2. The terms for brokered CDs are more flexible. Terms typically range from one to 20 years (although there are some brokered CDs with terms of up to 30 years). The fixed-interest of the underlying CD can help investors plan for steady growth with a long-term investment strategy. However, rising interest rates can be a missed opportunity for growth as a CD’s interest rate is locked-in at purchase.
3. The interest on a brokered CD is distributed on a regular interval — be it monthly or semiannually, for example — and doesn’t compound automatically as it does in a traditional CD. Interest must be reinvested manually.
4. Multiple CDs from more than one bank or credit union can be purchased under one brokered CD account. This allows investors to spread a larger investment across multiple CD accounts and take advantage of FDIC or NCUA insurance limits. While the brokered CD may not be insured directly, the underlying CDs from federally insured banks and credit unions are covered against bank failures.
5. A brokered CD can be sold at any time. Unlike a traditional CD that imposes penalties if money is withdrawn before the term expires, a brokered CD is sold on the secondary market if invested funds are needed. Current interest rates will determine if a brokered CD is sold at a profit or loss.

How is a brokered CD different from a bank CD?

A traditional CD is a deposit account that’s opened directly with the issuing bank or credit union. The CD is insured by the FDIC or NCUA for up to $250,000. The interest rate is fixed and the deposit is intended to be left untouched to grow until the CD reaches the end of its term. 

A brokered CD is offered by brokers and investment firms that consist of a group of traditional CDs as its underlying asset. While these CDs also offer a fixed interest rate, the yield is generally higher, the terms are more flexible and there is a secondary market for a brokered CD. “It’s easier to cash out early if necessary. However, while there’s no penalty for secondary market selling, you may incur a small sales fee. This means that if rates start to fall, you can still make a profit, as you can sell your brokered CD before the maturity date,” Silvermann said.

Pros and cons of a brokered CD

Pros

• Convenience: Large amounts of money can be deposited across multiple CD products using one brokerage account. 
• Liquidity: There are no early withdrawal penalties imposed. A brokered CD is traded on a secondary market and can be sold at any time.
• Longer terms: Terms can reach up to 20 to 30 years for a brokered CD, locking in a fixed-rate growth for the entire period. Traditional CDs, however, have shorter terms, usually between three months and five years.
• Safety: A brokered CD has FDIC or NCUA insurance from the issuing bank or credit union, provided that the brokerage firm partners with a federally insured bank or credit union.
• Higher return: Generally, a brokered CD earns a higher rate of return than a traditional CD. As with any investment, compare rates to locate the best APYs.

Cons

• Loss: Rising interest rates could likely cause a loss of money for a brokered CD that’s sold before the term expires.
• Fees: While there are no early withdrawal penalties, there are fees incurred when you buy or sell a brokerage CD which will cut into the overall investment returns.
• Callable: A brokered CD can be called by the issuing bank. When this occurs, the investment is refunded and you can lose out on future earnings. You don’t lose your initial investment or any gains earned to date. Banks recall a CD when interest rates drop to avoid paying higher rates than the investment generates.

When should you buy a brokered CD?

• Depositing a large amount of money: If you have a larger deposit in excess of $250,000 that you want to hold in one account, a brokered CD can help. Multiple CDs can be purchased through one brokerage account, spreading the insured risk over several CD accounts and providing one point of management. 
• The interest rate on a brokered CD is higher than a traditional CD: A brokered CD can offer a higher rate of return for a fixed-rate APY. This can provide greater returns while also providing the safety that savers seek in a  traditional CD.
• Lock in a rate over a longer period of time: If a traditional CD is too short to meet your long-term financial goals, a brokered CD will enable you to lock in a fixed-rate APY over a period of between one to 20 years or more.
• Liquidity: You won’t incur early withdrawal penalties if you need to access your money before the brokered CD’s term expires. However, there is a risk of loss if interest rates are higher because your CD value may be worth less. If you need to sell your brokered CD, be mindful of fees as they will take away from your overall returns.

There are situations, however, when a traditional CD is ideal over a brokered CD:

• Less complexity: You prefer a less complex investment that offers a fixed-rate growth and is definitely insured against loss. 
• Automatic reinvestment: You want a product that reinvests the interest automatically so interest compounds.
• Ease of use: The amount of money you need to save is covered by either the FDIC or NCUA and you don’t need to purchase and manage multiple CD accounts across multiple financial institutions.
• Avoid callability: You don’t want the risk of purchasing a callable investment product and lose out on future earnings.
• Smaller amount to invest: You have an initial deposit that is less than the typical brokered CD minimum deposit of $1,000.

How to buy a brokered CD?

A brokered CD must be purchased through a brokerage or investment firm. Setting up an account is a straightforward step, much like any banking or savings account. Generally, these can be handled through a broker’s website or mobile app. 

After establishing the account, money can be transferred from any linked bank account to fund your purchase. Review the brokered CD options available from the brokerage firm and keep in mind the following factors:

• Minimum deposit: Brokerage firms set a minimum deposit, generally $1,000, to purchase a brokered CD. There may also be a minimum amount to deposit additional money into a brokered CD account.
• Fees: Understand the fees associated with purchasing or selling a brokered CD.
• Callable vs. noncallable: Brokered CDs can be callable, which means that the bank can refund your purchase. This happens if interest rates drop and the bank is paying a higher interest rate than they can charge. 

Are brokered CDs safe?

A brokered CD is safe provided that the underlying CDs are issued by banks insured by the FDIC or credit unions insured by the NCUA. This is not always the case, as some underlying CDs may be issued from uninsured banks or credit unions. If insurance is important to you, confirm whether the broker has partnered with a bank or credit union that offers federally insured accounts. Many brokerage firms do partner with banks that provide this type of protection, so locating safe options should not be difficult.

Can you lose your money in a brokered CD?

Yes, if you sell it before the term expires. The value of the brokered CD is based on current interest rates. In a rising interest rate environment, a brokered CD may sell for less than what it was once worth, diminishing the value of your investment. Selling also incurs fees from the broker which will also diminish the returns.

The bottom line

Investors with large deposits can use a brokered CD to safely spread their cash between multiple CD accounts that are issued by federally insured banks and credit unions. A brokered CD is available for purchase through a brokerage firm and is traded on a secondary market like a savings bond. It’s a useful option if you’re looking for higher yield, need more liquidity in a savings product, want your money to grow over a longer term, and need federally insured protection to cover deposits with more than $250,000 in one account.