Understanding brokered CDs

Investors often use certificates of deposit (CDs) to inject stability to a portfolio during times of market volatility. Fixed-income investors often invest in CDs because compared to many other types of investments, they can offer shorter terms, competitive yields and FDIC insurance.

While purchasing a bank CD is the most straightforward way to add CDs to a portfolio, CDs purchased through a broker (brokered CDs) offer more versatility and potentially higher returns—although they also come with additional risks¹. Brokered CDs are similar to bank CDs in several ways, but they also have some features that resemble more traditional investment products. Here’s what you need to know:

CDs are “cash equivalent” bank accounts, opened as either an individual or a joint account, in which you deposit a certain amount of money with a bank upfront, and they agree to pay you back at a set annual percentage yield for a set period, no matter what happens to interest rates during that period.

At the end of that term, which can range from one month to several years, you can either cash out the CD or roll it over into a new CD with market terms. If you need to cash out before maturity, you may have to pay an early withdrawal penalty, typically a few months’ interest.

If you have a brokerage account you can also use it to purchase a brokered CD. In that case, you can:

• Choose from newly issued CDs from banks throughout the country and purchase that CD with funds in your brokerage account.
• Also purchase a brokered CD on the secondary market and potentially sell your brokered CDs on the secondary market before they reach maturity.

One other important difference between bank and brokered CDs: Bank CDs pay compound interest and brokered CDs pay simple interest.

Like all financial products, there are pros and cons to brokered CDs.

One of the biggest advantages of brokered CDs is that they may provide more flexibility to investors than bank CDs. Rather than having to choose a CD from the handful offered by your bank, you can select a CD from the many banks, nationwide, that have made their CDs available for purchase through brokerages. That means, you can often find brokered CDs with more competitive rates, different maturities (up to 20 years long), and variable interest rate structures.

Other advantages include:

• Potential for broader insurance coverage: FDIC insurance covers up to $250,000 in CDs per depositor at a given bank. However, if you purchase brokered CDs issued by different banks, you are eligible for FDIC insurance up to $250,000 per bank.
  • You must aggregate all deposits that you maintain with the bank by account ownership, including those that you hold at the bank through other intermediaries. There are conditions for obtaining FDIC insurance coverage held through such intermediaries.
• Liquidity: Rather than paying early withdrawal fees to cash out a CD before it reaches maturity, brokered CD owners may be able to sell their CD in the secondary market, subject to market conditions.
• Survivor’s options: Most brokered CDs offer estate protection, meaning that if the CD owner dies, their heirs can redeem the CD at face value, regardless of the current market price.
• Streamlined management: If you have multiple brokered CDs through one brokerage account, it’s easy to see and track them all at once, without having to log into multiple accounts.

Brokered CDs involve more complexity than bank CDs. So before investing in brokered CDs, it’s important to understand the risk involved. These include:

To help mitigate the above risks², consider purchasing brokered CDs with a plan to hold them until maturity, and to keep your holdings at any given bank below the $250,000 insurance limit.

With predictable returns, brokered CDs are one way to diversity a portfolio using fixed income, especially in times of market volatility. Whether they make sense as an investment for you will depend on several factors, including the amount you want to invest, your risk tolerance, and your personal financial goals.

¹Link to recent SEC Investor Bulletin on brokered CDs, 2024

²Link to E*TRADE’s CD disclosure statement