With interest rates likely at their peak, it’s time to strike while the iron is hot. Federal Reserve Chair Jerome Powell has indicated that interest rates probably won’t go any higher and has even suggested rate cuts later this year.
By investing money in cash equivalents, such as certificates of deposits (CDs), you can keep the interest payments flowing for years or even decades regardless of what the Fed does.
Like traditional CDs, a brokered CD is a type of deposit account where you deposit a lump sum of money in exchange for regular interest payments. Brokered CDs, however, can be a bit more complicated than bank CDs, so you’ll want to know the ins and outs before investing.
How do brokered CDs work?
Brokered CDs are issued by banks and sold to brokerages in bulk. Brokerages then turn around and sell those CDs to customers.
Since brokerages purchase them in bulk, they can negotiate better interest rates on brokered CDs and offer higher rates than those on traditional CDs. While you can score a higher annual percentage yield (APY) with a brokered CD, brokered CDs typically only provide simple interest rather than compound interest.
When you purchase a brokered CD, you either buy a newly issued CD or CD on the secondary market. If you purchase a CD on the secondary market, you’re buying it from another market participant instead of the brokerage.
Some brokerages may require a minimum investment to open an account and increments of certain amounts, such as $1,000.
Even though brokered CDs are purchased through a brokerage, they’re still covered by Federal Deposit Insurance Corp. (FDIC) insurance as long as the bank that issues them is FDIC-insured. You can check if a bank is FDIC-insured online.
Since you can purchase CDs from multiple banks through your brokerage account, it’s possible to invest more than $250,000 in brokered CDs while still being covered by FDIC insurance. Just make sure you don’t exceed the $250,000 per insured bank for each account ownership category limit.
Brokered CDs vs. traditional CDs
There are some significant differences between brokered and traditional CDs. With a traditional CD, you’ll have to pay an early withdrawal penalty (usually worth a few months of interest) if you want to access your money before the CD’s term expires.
Best traditional CDs by term length
Meanwhile, brokered CDs offer much more flexibility and liquidity than bank CDs. If you want to tap your money early with a brokered CD, you can sell it on a secondary market (but there may be a fee).
Yet, with greater flexibility comes greater risk. For example, if interest rates rise after you’ve purchased a brokered CD and you want to sell it, you may have to sell it at a lower price because your CD is less attractive to other investors now. Therefore, you may incur a loss.
Another potential disadvantage of brokered CDs is that some have call provisions. CDs with call provisions are known as callable CDs. With a callable CD, the issuing bank can terminate it before it reaches maturity. Typically, banks do this when interest rates drop because they can save money by issuing new CDs with lower interest rates to customers.
When a CD is called, you’ll get to keep the principal and any interest you’ve already received but will miss out on future interest payments.
You’ll also have to reinvest your funds at a lower interest rate. This is known as reinvestment risk and is why callable CDs typically offer higher APYs than others.
Is a brokered CD right for you?
To determine whether a brokered CD is right for you, you’ll want to consider your investment horizon, financial goals, liquidity needs, and risk tolerance.
“If a client had a more near-term goal, we would assess risk tolerance and timeframe associated with that goal,” says Matt Fleming, a wealth advisor executive at Vanguard. “There could be a number of different liquid short-term investment solutions like checking and savings accounts, money market accounts, bank CDs, brokered CDs, short-term bonds, or short-term bond funds.”
When choosing between a bank or a brokered CD, Fleming recommends that investors opt for a brokered CD if they plan to invest more than $250,000 or if they want the convenience of selling their CD before maturity.
Where to find brokered CDs
Brokered CDs can be found at, you guessed it, brokerages. Popular online brokerages, such as Vanguard, Charles Schwab, Fidelity, and E*TRADE, offer brokered CDs.
Right now, many of these brokerages are offering rates that top 5% on brokered CDs:
- Charles Schwab: Up to 5.41%
- Vanguard: Up to 5.40%
- Fidelity: Up to 5.30%
Pros and cons of brokered CDs
Pros
- More liquidity. You can sell your brokered CD on a secondary market if you want to access your money before the term is up.
- Higher APY. You’ll typically get a higher APY with a brokered CD than you would with a traditional CD.
- Greater FDIC coverage. By investing in CDs issued by different FDIC-insured banks, you can invest more than $250,000 and still be covered by FDIC insurance.
Cons
- Interest rate risk. If you're thinking of tapping into your cash before your CD matures and interest rates have dropped, be prepared to sell it on the secondary market at a loss. Plus, there's a chance you'll have to pay fees.
- Interest isn’t compounded. You’ll usually earn simple interest in a separate account.
- Call risk. If your CD has a call provision and interest rates decline, the bank might redeem your CD before it matures, which means you won’t receive any future interest rate payments and have to reinvest your money.
Alternatives to brokered CDs
Brokered CDs might not be the right choice for every investor. If you want easy access to your money or are looking for a place to store your emergency fund, you’re better off stashing your money in a high-yield savings account or money market account (MMA).
With a high-yield savings account, you can earn a stellar interest rate and still tap your cash as needed. (Note that banks may restrict the number of withdrawals you can make each month.) Some of the best high-yield savings accounts offer yields above 4.50%.
If you want to access your cash via an ATM card, checks, or a debit card, consider getting an MMA instead. With some of the best MMAs, you’ll get an APY that tops 5% and be able to acquire cash in many different ways.
The takeaway
Unlike bank CDs, which are fairly illiquid, investors who opt for a brokered CD can sell their investment on a secondary market if they want their money before it matures. However, investors should be cautious of brokered CDs with call provisions and check that an FDIC-insured bank issues their CD to ensure their money is safe.
