Brokered Certificate of Deposit (CD)

What Is a Brokered Certificate of Deposit (CD)?

A brokered certificate of deposit (CD) is a CD that an investor purchases through a brokerage firm or from a sales representative other than a bank. Although the bank still initiates the CD, it outsources selling it to firms offering incentives to attract new investors. The broker invests a considerable sum with a bank, then sells off that investment in smaller pieces to a variety of investors as brokered CDs.

Understanding Brokered CDs

Brokered CDs generally command a higher yield than bank CDs, as they are in a more competitive market. The broker has invested a large sum with the bank, and that generates more interest than smaller amounts. As with all CDs, holders receive the full principal with interest at maturity.

In general, CDs are savings certificates. While many retail banks offer CDs, they are more complex than other financial services, such as checking and savings accounts. CDs will have a fixed maturity date and fixed interest rate. They can be issued in any denomination and may have minimum investment requirements. The holder of a CD cannot access the funds until the maturity date of the investment without paying a penalty. However, brokered CDs can usually be sold on the secondary market.

CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per individual at each bank. Brokered CDs are technically not FDIC-insured. However, the broker’s underlying CD purchase from the bank is insured. That makes it essential to buy them from a financially sound company.

On the plus side, a broker often has investments in multiple CDs from different banks. Wealthy investors can spread their money among brokered CDs from various banks, with a $250,000 FDIC insurance limit for each bank. This strategy is much easier than actually opening accounts at several banks and often more profitable than buying U.S. Treasury bonds.

Advantages of a Brokered CD

Brokered CDs generally offer much more flexibility than traditional bank CDs. For example, brokered CDs can have much longer terms than bank CDs, up to 20 to 30 years in some cases.

The secondary market for brokered CDs also makes it much easier to get money out early. There is no actual penalty for selling on the secondary market, but there is sometimes a small sales fee.

If interest rates fall, you may even be able to make a profit when selling a brokered CD before it reaches maturity.

Brokered CDs also frequently have higher yields than standard bank CDs. Given the inherently low risk of most short-term CDs, that is a substantial advantage.

Disadvantages of a Brokered CD

The flexibility of brokered CDs can make it easier for investors to make mistakes. In particular, buying a long-term brokered CD exposes investors to interest rate risk. A 20-year brokered CD can decrease substantially in price if an investor has to sell it on the secondary market after a few years of rising interest rates.

There is a different risk when interest rates fall. Many brokered CDs are callable CDs, so the issuer will probably want to call it and refinance if interest rates go down.

Brokered CDs can be much riskier than traditional bank CDs if investors are not careful.

Some investors rely on the penalties attached to early CD withdrawals to keep them from spending the money on consumer goods. Brokered CDs cannot provide this discipline because they can be sold on the secondary market.

Interest earned on a brokered CD is not compounded, as it is with a bank CD. If you want compound interest from brokered CDs, you must reinvest your earnings in another account.

Brokered CD vs. Bull CD

A brokered CD should not be confused with a bull CD. A bull CD’s interest rate correlates directly with the value of its underlying market index, which makes it a market-linked CD. Investors in many bull CDs are guaranteed a minimum rate of return, as well as a specified percentage of gains by a market index. The interest rate a holder of a bull CD receives increases as the value of the market index rises.

Brokered CD vs. Bear CD

By contrast, a bear CD’s interest rate moves in the opposite direction of the value of its underlying market index. In this scenario, the interest rate paid on the CD increases only if the underlying market index decreases. Investors will select bear CDs primarily for speculating and hedging.

Bear CDs can be desirable if an investor has a long position that is highly correlated to the underlying market index. Investing excess cash in a bear CD can help to offset losses elsewhere.

Brokered CD vs. Yankee CD

Similar to a Yankee bond, a Yankee CD is issued by a branch or agency of a foreign bank in the United States to American investors. The selling, however, is not outsourced to a second party, as with a brokered CD. A Yankee CD is denominated in U.S. dollars. Many foreign companies choose to raise capital from U.S. investors by issuing Yankee CDs.