Brokered CDs give banks the chance to raise capital from far-flung corners of the country, and investors the opportunity to earn better than average returns on their savings since 10 Year Treasury Yields are driving all traditional income investments to near zero yields.
But there are a few things you should know before you buy a brokered CD.
8 Things to Know about Brokered CDs
- “No early withdrawal fees” is a farce – There are no early withdrawal fees on a brokered CD because you cannot make an early withdrawal. Instead, you will have to sell your brokered CD on the secondary market, where it may be priced at less than its face value.
- Records are everything – Investors who purchase a brokered CD should be sure that the broker indicates you are the owner and the broker is merely the trustee. The FDIC only insures deposits of up to $250,000, and most brokers will hold much higher balances for a combination of clients. Save the future headache and be sure that the FDIC knows that the broker is simply holding your funds, not the broker’s.
- Paying a premium can bite you – Paying a premium above the face value of a brokered CD can come back to bite. A callable certificate of deposit acquired at $1.05 on the dollar will be called at face value – one dollar – leaving you with a loss of 5%. Additionally, the FDIC only insures the face value of the certificate of deposit. In the case of a bank failure, you’ll be left to eat the loss from the premium.
- Brokered CDs are more honest – Look at any of the highest-yielding CDs on the market and you will see the tricks banks play to lock-in their clients. Bank CDs now have automatic rollovers that automatically reinvest their clients cash at the market rate unless a client writes the bank within the required window to opt out. Brokered CDs end when they end – and laws require brokers to provide periodic statements to their clients detailing their CD investments. Read: you won’t forget you own a brokered CD; it is easy to forget you own a bank CD.
- Riskier banks sell at a discount – A (very old) source shows how investors are rewarded with much higher yields from banking institutions with lower ratings. The table shows how 3-star rated institutions’ CDs were sold at a 2-2.25% discount to intrinsic value when 4-star CDs sold for a 1% discount to intrinsic value. Considering that all CDs on the table are FDIC insured, there really isn’t much risk to buying lower-rated CDs – especially when rates have nowhere to go but up.
- Prices fluctuate with rates – Brokered CDs trade like bonds. In the event rates rise, your CDs will be less valuable. When rates drop, your CDs will become more valuable. This variable may be more rewarding for people who want the option to speculate on interest rates.
- Brokers work for troubled banks, too – Brokered CDs were the staple financing source for banks like IndyMac. At the time of its collapse, IndyMac’s balance sheet was 37% financed by brokered deposits from investors all over the country. The bank lured investors with high CD yields only to be later seized by the FDIC. (Getting your money back from a broker takes 60-90 days whereas the FDIC normally pays out bank CDs in a matter of 7-10 business days.)
- You can negotiate – More money means more power. Large accounts of $100,000 or more can be shopped around for the best possible rates. Regional banks are the most likely to negotiate with customers for higher rates on a brokered CD because they are not as tied into the capital markets as larger banks. Online banks are typically “one-size fits all” and are less likely to negotiate because they have an already strong national reach through the internet. You can also negotiate with the broker, who invariably takes a cut from every CD sold.
When Brokered CDs Make Sense
Investors who can commit to the long haul get paid for their commitment. Brokered CD downsides – limited liquidity and rate sensitivity – are only concerns if you need to liquidate your investment before the CD reaches maturity.
If you’re committed to making a large, long-term investment in a certificate of deposit, it stands to reason that your best bet is in a brokered CD. If seeking even higher yields, especially in a tax-deferred account, check out How I beat the Market with my Roth IRA.
Do you own any brokered CDs?