Investors often seek a balance between achieving the highest available yield and maintaining the risk characteristics they’re comfortable with. In recent years, many investors favoring lower-risk options have shied away from CDs due to historically low interest rates. A strengthening economy and the actions of a hawkish Federal Reserve have contributed to significantly increased rates—and a resurgent interest in CDs. Let’s take a look at the benefits and risks associated with CDs, and the resources E*TRADE makes available to clients interested in this conservative, potentially income-generating product.
What are certificates of deposit?
In order to finance their lending activities, banks often issue certificates of deposit (CDs). When a CD is purchased, you are agreeing to deposit your funds with a bank for a specified period commonly referred to as a “time deposit.” During this period, the funds will earn a stated rate of interest until maturity. That interest is usually paid to the investor at regular intervals during the term of the CD, which can range from one month to several years. Generally speaking, the longer the term, the higher the stated interest rate. Upon maturity, the full value of the initial deposit will be returned along with any accrued interest due.
You may have heard of multiple types of CDs, such as traditional CDs offered by banks or brokered CDs. Like bank CDs, brokered CDs are debt obligations of the issuing bank; however, with brokered CDs the issuing bank has decided to make these instruments available via third-party intermediaries, like E*TRADE Securities.
Traditional CDs vs. brokered CDs
Brokered CDs and bank CDs share many characteristics, but there are a few key differences you should be aware of—namely insurance coverage, early withdrawal penalties, and liquidity.
As the vast majority of banks are FDIC members, most CDs feature federal deposit insurance coverage up to $250,000 per depositor, per insured bank.† Since brokered CDs can be purchased from multiple issuing banks and held in your E*TRADE account, you have the ability to essentially garner additional FDIC protection by diversifying your CD positions across multiple issuers.
†All brokered CDs available on E*TRADE.com feature FDIC Insurance coverage to applicable limits.
Investors should also be aware of any potential early withdrawal fees and liquidity considerations for their CD investments. When purchasing a traditional bank CD, investors may be subject to early withdrawal fees assessed by the bank if they elect to withdraw their funds prior to maturity. However, brokered CDs give investors the opportunity to sell their CDs prior to maturity on the secondary market, offering enhanced liquidity.
Additional benefits of brokered CDs
Let’s uncover some additional benefits associated with brokered CDs.
- Competitive yields. Conservative investors who’ve traditionally sought low-risk debt solutions may be surprised at the competitive yields today’s brokered CDs offer. In recent years, some investors have considered riskier alternatives to achieve satisfactory yields, but many are finding that new brokered CD issuance is providing attractive rates. When comparing the monthly averages from January 2017 through September 2018, rates for three-month, six-month, and one-year brokered CDs have increased by 210.3%, 203.8%, and 132.1%, respectively.
- Structure variety. There are a wide variety of features to consider when investing in brokered CDs, depending on your investment goals. E*TRADE offers access to both new issue and secondary market offerings of brokered CDs from hundreds of different issuing banks. With terms ranging from as short as three months to as long as 30+ years, you can invest according to your liquidity needs. Brokered CDs also have a variety of redemption and interest features to consider. While fixed-rate CDs are the most common form, other interest rate structures offer additional flexibility, including zero-coupon, step-up rate, or floating-rate CDs. In addition to interest rate features, CDs have callable or non-callable redemption options.
- Estate protection. Most brokered CDs offer estate protection, more commonly referred to as a “survivor’s option” or “death put” provision. This feature allows for the investment to be redeemed at face value, regardless of the current market price, upon death of the account holder.
- Preservation of capital. If one of your primary objectives is to avoid capital loss, CDs are a popular asset class to consider thanks to the availability of short terms and FDIC insurance coverage.
- Diversification. This conservative investment product may help diversify your portfolio and add stability during volatile market periods.
Risks of brokered CDs
Like other investments, there are certain risks associated with investing in CDs. Let’s delve deeper into some of these risks and potential ways to mitigate them.
- Interest rate risk. The market value of a CD, if sold or called prior to maturity, will be effected by current interest rates. When interest rates rise, the market price of an outstanding CD will generally decline. Therefore, selling a CD on the secondary market in a rising interest rate environment could result in a potential loss on your initial investment. If you’re exposed to high liquidity risk, it may be worth considering shorter maturities to reduce interest rate risk.
- Credit risk. Although CDs are typically considered to be a low risk investment, there is still the possibility that the issuing institution could default. While FDIC insurance helps mitigate potential loss of principal, up to applicable limits, it is important investors evaluate the creditworthiness of the issuing bank. Investors should also track their total deposits to ensure they do not exceed FDIC insurance limits at any one bank.
- Liquidity risk. While brokered CDs offer increased liquidity with the ability to sell on the secondary market, there is no guarantee investors can liquidate prior to maturity. If a buyer is found, you may also need to sell your CD at a discounted level from your purchase price. To lessen the risk of losing money on a CD investment, investors should buy a CD with the intention on holding it to maturity.
E*TRADE tools and resources
E*TRADE offers an array of tools and resources to assist you in searching for the right CD to align with your investment needs.
- CD search tools. Finding the right CD investment is easy on etrade.com. For quick searches, consider the “Yield by Category” search table on the Bond Resource Center homepage. To further tailor your search, use our Advanced Bond Screener to take advantage of a broad range of customizable criteria.
- Bond Ladder Builder. A bond ladder is a portfolio of fixed income securities that mature at regular, staggered intervals. Whether you are looking to support ongoing cash flow needs or fund a large purchase in the future, a CD ladder can help generate income based on your unique situation. Take advantage of our Bond Ladder Builder for step-by-step guidance through the bond ladder building experience.
- Fixed Income Specialists. E*TRADE offers clients complimentary access to our Fixed Income Specialists. These highly experienced professionals can assist you in choosing a CD that fits your investment objectives, or designing a customized CD ladder to match your individual needs. Contact a Fixed Income Specialist today at 866-420-0007.