Do you want to know a little personal finance secret that hardly anyone knows about? If you are interested in a safe and higher-yielding investment, there is this secret CD, with rates that are much higher than those you can find through your bank. These secret higher-yielding CDs are called brokered CDs, and you can buy them only through Vanguard, Fidelity, Schwab or any brokerage firm.
What is a brokered CD?
A brokered CD is a type of CD or certificate of deposit. You purchase a brokered CD through a brokerage firm rather than directly through a bank. It’s FDIC-insured. CD rates are often higher than a savings account because you have to lock it in for a certain period of time. The terms typically range from 3 months to 10 years.
Multiple CDs from more than one bank or credit union can be purchased under one brokerage account. The brokers set a minimum investment amount which is usually around $1,000. You can then add funds to a brokered CD in any amount but usually in increments of $1,000.
No one has been paying attention to CDs since 2008 (Great Recession) because rates have been really low. Previously, you needed to lock your money for a very little return. However, now you can buy a regular 1-year CD at a 4% return; higher if you buy a brokered CD.
How do brokered CDs pay interest?
The issuing bank will determine when interest is paid on the brokered CD. If the CD term is one year or less, then the interest is usually paid on maturity. If the term is beyond one year then banks generally pay interest semiannually, quarterly, or monthly.
What makes brokered CDs unique?
- You can get a much higher CD rate if you buy a brokered CD.
- You can only buy these higher-yielding brokered CDs through a brokerage firm, like Vanguard or Fidelity.
- The minimum investment is typically $1,000. You can also buy Fractional CDs in Fidelity for $100.
- There is no limit!
Pros of brokered CDs
- Liquidity: Traditional CDs require you to keep money in the account for a specified period of time. With a brokered CD, you can sell the CD on the secondary market at any time without an early withdrawal penalty. However, a sales fee may apply.
- Terms: There are more terms available with brokered CDs than with traditional CDs. Brokered CDs can have terms of 3 months, 6 months, 9 months, and 18 months, which are typically not available for traditional CDs.
- Convenience and diversification: You can purchase brokered CDs from more than one bank and keep them in one account. This means that you don’t have to open accounts with a variety of banks to achieve diversification.
- Higher interest rates: Brokered CDs typically carry higher interest rates than those found at banks.
- Locked interest rate: CDs protect your money from falling interest rates because you lock in your interest rate from opening to maturity.
Cons of brokered CDs
- Higher risk: You can potentially lose money if you sell them too soon.
- Fees: There are sometimes fees for selling your brokered CDs which can cut your overall earnings.
- Callable: Some brokered CDs can be called back before their maturity date. When this happens, then the investment is refunded and you will lose out on any future earnings.
- Locked interest rate: CDs are protected from falling interest rates but this also means that it prevents you from taking advantage of rising interest rates. A CD ladder can help minimize this disadvantage.
What is a CD ladder?
A CD ladder is when you open several CDs each with a different maturity term. When a CD matures, then you can choose another CD to invest in. This means that you can take advantage of the changing interest rates while still allowing you to access portions of your CD regularly.
For example, a CD ladder could involve opening 4 different CDs such as a 3-month CD, a 6-month CD, a 9-month CD, and a 1-year CD. After 3 months, your 3-month CD will mature. You would take the money from that CD and put it into another CD. You would keep doing this so you will always have a CD maturing every three months, in case you need the money.
Can I withdraw my brokered CD if interest rates increase?
If interest rates increase you may be tempted to withdraw your brokered CD to buy a higher-yielding CD. We generally recommend that you keep your brokered CD until it matures so you get the full interest. If you sell your brokered CD after interest rates rise, then you will have to sell your CD at a loss.
You can sometimes withdraw CDs without an early withdrawal penalty so check with your institution. You will then need to do a calculation to determine if and when it’s right to withdraw your CD. It’s important to talk to your financial advisor to decide if it’s beneficial for you to withdraw your CD or continue to keep your CD until it matures.
How are brokered CDs taxed?
The interest that you earn from your brokered CDs and bank CDs are generally considered regular income and subject to federal and state income taxes. If you earn $10 or more in interest in a year then the bank or institution will send you a 1099-INT form to include on your tax return. Even if you don’t receive this form, you are still required to report earned interest on your taxes. It is possible to defer the taxes by holding your CDs in an IRA rather than a taxable brokerage account.
How do I avoid tax on CD interest?
The only way to avoid taxes on CD interest is if your CD is purchased in a tax-advantaged account such as an IRA.
What’s the difference between a regular bank CD and a brokered CD?
- Where you can buy: A brokered CD is offered by brokers and investment firms and is purchased through a brokerage firm. A regular CD is a deposit account that you have to open directly with the issuing bank.
- Early withdrawals: If you withdraw a regular bank CD before the end of a term, you get your money back, forfeit any interest, and maybe pay an early withdrawal penalty. Brokered CDs are unique because you can sell them on the secondary market before the CD even matures. If you sell it on the secondary market then you won’t pay an early withdrawal fee. However, since the price of brokered CDs fluctuates, you may lose money if you sell it early while interest rates are higher than they were when you purchased the CD. You may also need to pay the broker a fee for selling the CD on the secondary market.
- Interest rates: Brokered CDs have a higher percentage yield than regular bank CDs. Brokered CDs usually pay out a simple interest monthly, semi-annually or annually. This is calculated only on the principal since there is no compounding interest.
- Diversification: For a brokered CD, you can select a variety of CDs from different banks within one brokerage account. For a regular bank CD, you have to open up different accounts for each CD that you want to purchase.
- Terms. Both regular bank CDs and brokered CDs have various terms, however, brokered CDs usually have more term options available.
What are some similarities between a regular bank CD and a brokered CD?
- Both are issued by a bank.
- Both are typically FDIC-insured. Regular bank CDs are always FDIC-insured and the majority of brokered CDs are FDIC-insured. If you purchase brokered CDs, always check that they are FDIC-insured.
- Both offer various term maturities.
Brokered CD vs Regular Bank CD
|Brokered CD||Regular bank CD|
|Issuer||Bank or credit union||Bank or credit union|
|Point of purchase||Brokerage firm||Bank or credit union|
|Insured by either FDIC or NCUA?||Mostly||Yes|
|Interest compounds automatically||No||Yes|
|Typical terms||3 months to 10 years||3 months to 5 years|
|Interest payout||Monthly, semiannual or at maturity||At maturity|
|Early withdrawal penalty||No||Yes|
|Purchase fees||Typically No||No|
Are brokered CDs better than regular bank CDs?
If you want a higher rate and more flexibility, then brokered CDs are generally better than regular bank CDs.
What are the current brokered CD rates for 1 year?
If you’re looking for a 5.75% brokered CD rate then you can buy a 13-18 month brokered CD in Vanguard.
Are brokered CDs as safe as bank CDs?
Yes, brokered CDs are as safe bank CDs as long as they are FDIC-insured. Always check that the brokered CD is FDIC-insured before purchasing.
Can you sell a brokered CD early?
Brokered CDs can be sold early on the secondary market. However, it’s generally recommended to hold on to the brokered CD until it reaches maturity. If you sell it on the secondary market then you may also lose money if the CD has lost value.
There are risks to buying and selling on the secondary market. You will want to make sure that you are working with reputable sellers/buyers. You can verify the buyer or seller details with the Financial Industry Regulatory Authority.
Can you lose money in a brokered CD?
Yes, you can lose money in a brokered CD if you sell it before the term expires. The value of the brokered CD is based on current interest rates. If interest rates rise, then the brokered CD may sell for less than what it was originally worth. When you sell a brokered CD, the broker may also charge a fee which will mean fewer returns.
When should I purchase brokered CDs?
- If you are looking for a higher interest rate and don’t mind locking your money during a certain period.
- If you are depositing a large amount of money that you want to hold in one account then a brokered CD can be a great option. Multiple CDs can be purchased through one brokerage account which may reduce your overall risk.
- If you want to lock up some money for a term longer than 5 years then you will need to choose a brokered CD.
- If you want to keep your cash liquid then a brokered CD will be the better choice. You won’t incur any early withdrawal penalties however there will be fees that will take away from your overall returns.
How do I purchase brokered CDs?
If you want to purchase a brokered CD, then you need to have an account at a brokerage firm that sells brokered CDs.
How do I buy brokered CDs in Fidelity?
- After you log in to your Fidelity account, click on the ‘Trade’ button and a box will appear.
- Click on the first drop-down menu and change it from ‘Stocks/ETFs’ to ‘Fixed Income’.
- Click on ‘Search Inventory’.
- Once the ‘Fixed Income, Bonds & CDs’ web page opens, click on the fourth tab ‘CDs And Ladders’.
- You can then choose the term and bank that you want and then click ‘Buy’.
- Once the new landing page opens, select an account from the drop-down menu and then provide the amount that you want to invest.
- Review your order details and then submit your order.
How do I buy brokered CDs in Vanguard?
- After you log in to your Vanguard account, click on ‘Buy & Sell’ within the ‘My Accounts’ tab. Once you are on the landing page, select the ‘Buy CDs’ link.
- Select which account you want to use for your purchase and then click continue.
- Go to the ‘Select CD maturity’ dropdown menu and select the length maturity you want.
- Select a bank from the list.
- Provide the amount that you want to invest.
- Review your order details and then when you are ready to proceed, click ‘Submit CD purchase’.
- You have now purchased a brokered CD and will be taken to the confirmation screen.
Add brokered CDs to your investment portfolio!
Brokered CDs can be a great addition to your investment portfolio if you are looking for higher rates, more liquidity, and more term options. If you are interested in having a comprehensive financial plan, schedule a free discovery call with one of our fee-only financial advisors today.
Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help professionals in their 30s and 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.