A Brokered Certificate of Deposit (CD) is a type of Certificate of Deposit issued by banks or thrift institutions. However, unlike traditional CDs, brokered CDs are purchased in bulk by brokerage firms, which then resell them to their customers. These financial instruments offer several benefits, including higher yields, federal deposit insurance, and liquidity.
Key Characteristics of Brokered CDs
Higher Yields
Brokered CDs typically offer higher interest rates compared to traditional bank-issued CDs, sometimes paying up to 1% more. This is because brokerage firms purchase these CDs in large quantities, often securing better rates which they can pass on to individual investors.
Deposit Insurance
Just like regular bank-issued CDs, brokered CDs are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per depositor, per insured bank. This provides a layer of security, assuring investors that their principal is protected, subject to FDIC limits.
Secondary Market Liquidity
Brokered CDs come with the advantage of a secondary market. This market is facilitated by the brokerage firm, allowing investors to sell their CDs before maturity without the penalties typically associated with early withdrawal from traditional CDs.
No Commission Fees
Investors purchasing brokered CDs do not usually pay commission fees. The brokerage firm earns money through the difference between the rate paid to the bank and the rate offered to the investor.
Types of Brokered CDs
Callable Brokered CDs
Callable brokered CDs allow the issuing bank the option to redeem the CD before maturity. These often come with higher yields but carry the risk that the CD could be called away, giving the investor their principal back sooner than planned.
Non-Callable Brokered CDs
Non-callable brokered CDs cannot be redeemed by the issuing bank before maturity. While offering slightly lower yields compared to callable CDs, they provide greater certainty regarding the investment term.
Risks and Considerations
Interest Rate Risk
Brokered CDs are subject to interest rate risk. If interest rates rise, the value of the CD on the secondary market may decline, potentially leading to a loss if sold before maturity.
Call Risk
Callable brokered CDs carry call risk, where the issuer might redeem the CD before maturity, possibly when interest rates decrease, leaving investors to reinvest at lower rates.
Liquidity Risk
While brokered CDs are generally more liquid than traditional CDs due to the secondary market, the liquidity depends significantly on market conditions and the brokerage firm’s ability to find a buyer.
Examples
Consider an investor who buys a $10,000 brokered CD at a 3% interest rate for a 5-year term. The investor earns $300 annually in interest. If interest rates rise, and the investor decides to sell the CD on the secondary market, they might retrieve less than $10,000 due to the decreased present value of lower-yielding CDs.
Historical Context
Brokered CDs became popular in the late 20th century as brokerage firms sought ways to offer higher-yielding products to their clients. The development of the secondary market further enhanced the appeal of these instruments as flexible investment options.
Applicability in Financial Planning
Brokered CDs are suitable for investors seeking higher yields and FDIC insurance without sacrificing the potential for liquidity. They play a critical role in diversified investment portfolios, especially for risk-averse investors.
Comparisons
- Traditional CDs: Typically have lower yields and lack secondary market liquidity.
- Bonds: Often involve higher risk and do not carry federal deposit insurance.
Related Terms
- Certificate of Deposit (CD): A savings certificate with a fixed maturity date and specified interest rate.
- Secondary Market: A market where previously issued securities are traded among investors.
- FDIC Insurance: Federal protection covering deposits up to $250,000 per depositor, per insured bank.
FAQs
Are brokered CDs safe?
Can I lose money with a brokered CD?
References
- FDIC Official Website. www.fdic.gov
- Investopedia. “Brokered CD”. Investopedia
Summary
Brokered CDs are an attractive investment vehicle offering higher yields, federal deposit insurance protection, and enhanced liquidity through the secondary market. Despite these advantages, investors must consider interest rate risks and the implications of callable features when incorporating brokered CDs into their financial strategies.
