Certificates of deposit (CDs) are a convenient way to save money. Since they are interest-bearing, your money grows as it sits untouched. By the time the CD reaches maturity, you will have more money than you put in, often compensating for inflation.
The most common way to take out a CD is directly from a bank. However, it is not the only way. In fact, depending on your particular situation, purchasing a brokered CD instead of a direct CD may be more profitable.
Brokered CDs are bought in bulk by brokerage firms from issuing banks and then sold to the firm’s clients. Since brokers shop around for CDs and purchase the ones with the most favorable terms, brokered CDs often have higher APYs than direct CDs.
This is one of the most attractive features of brokered CDs, especially if the market is currently offering lower rates. By purchasing a brokered CD, you will be able to lock in a higher rate than you would get if you went straight to a bank.
Purchasing a brokered CD is also a good idea if you’re concerned about your deposits being insured by the Federal Deposit Insurance Corporation. The FDIC has a coverage limit of $250,000 per depositor per bank. That is, you can’t have more than this amount in a single bank. Purchasing CDs through a broker is a simple way to diversify your deposits among several banks to ensure your money is still covered by FDIC insurance. A broker will be able to look at multiple institutions and 0ffer you the best deals.
Likewise, brokered CDs make creating CD ladders —a series of CDs with staggered maturity dates to maximize earnings and obtain higher interest rates— even easier.
Many brokered CDs have early withdrawal penalties just like direct CDs, but holders are able to sell a brokered CD on the secondary market, similar to bonds. Often, depending on the state of the market, this means the holder of the CD is able to make a profit.
As with everything, there are some disadvantages to taking out a brokered CD. For one, some brokered CDs are classified as securities. In this case, the FDIC will not insure the value of the CD, leaving holders exposed to the bank’s failure. If this is the case of the brokered CD you are holding, make sure to research the financial status of the institution that is storing the CD.
Another reason to rethink taking out a brokered CD is if the fees associated with the certificate negate any earnings. Brokered CDs are subject to brokerage fees, just like any other investment product purchased through a broker. Make sure to do the math and weigh the total amount of fees you will have to pay with the sum of the interest you will have earned at maturity. If the fees outweigh the interests, consider a longer maturity period or another CD.
Taking out brokered CDs to sell in the secondary market once market rates go down is a popular way of making a profit among investors. However, you must consider the possibility that market rates will actually increase and you won’t be able to make a profit by selling the CD. If this is the case, waiting until the CD reaches maturity is the surest way of making a profit.
If you're trying to decide whether to purchase a brokered CD, the FDIC offers some advice. Researching the reputation and terms of the broker is key to avoiding scams and predatory schemes. A reputable broker will almost always place your money in an FDIC-insured bank, and if they do not, they will be able to explain why.
Another warning is to be suspicious of brokered CDs with interest rates that are much higher than those offered by banks. It may indicate the certificate is issued by a bank that isn’t FDIC-insured. While this may not necessarily be a bad idea, you should always be aware of the risks involved with depositing your money in a bank without FDIC protection.
The FDIC also advises to find out if you can only cash in your brokered CD by selling it on the secondary market. This is one reason why short-term CDs are generally a better idea: if you can’t withdraw the money or pay the early withdrawal penalty, you only have to wait a short amount of time to withdraw the money. This is an especially good idea if interest rates are expected to go up in the future.
Finally, know your options if you are tricked or scammed by a disreputable broker. You can submit a formal complaint against a broker through FINRA, or a complaint against a product through the SEC.
For many consumers, especially those looking to invest in products similar to securities without running the risk of investing in financial products that aren’t insured by the FDIC, brokered CDs can be a great alternative to traditional CDs issued directly by a bank.