With the Federal Funds rate hovering just over 5%, CDs are popular once again. We’ve had a steady stream of requests from clients asking where to find the best rates and terms. This is where a brokerage CD comes into play but it’s important to know the difference between a traditional bank CD and CDs that are offered in a brokerage account. You will find a much greater assortment of choices with brokerage CDs compared to a single bank.
Most bank CDs will go anywhere from 3 months to 5 years. With a brokerage CD you can go as long as twenty years.
In a brokerage account you’re not limited to just one bank- you will usually have multiple banks to choose from. Which is helpful, especially when you are trying to keep under the $250,000 FDIC limit. An example of this is you can have multiple CDs from different banks in one brokerage account. If you have $500,000 in cash, you could buy two CDs from different banks at $250,000 each and still be 100% insured.
Brokerage firms have a lot more buying power than you or I do walking into a local bank asking for the best rates. Generally, you can find higher yields with brokerage CDs due to overall competition and volume.
Most of the time in a bank CD your interest compounds. With a brokerage CD, it does not. A brokerage CD pays its interest into the money market attached to your account. Brokerage CDs will differ in when they pay interest, too. They can pay monthly, quarterly, annual, or at maturity.
Penalties for early withdrawals
Bank CDs will usually charge you a penalty if you cash out before it matures. With a brokerage CD, they trade on the open market much like a bond does, so there are no formal penalties for early withdrawals. However, if interest rates rise, your CD could go down in value. Conversely, if rates go down, your value could go up.
Trading on the secondary market
Bank CDs do not trade on any market, but brokerage CDs do. Here is an example. You buy a $100,000 brokerage CD from Main Street Bank at first issue with a maturity of 7/1/24 and a coupon of 5%. If rates go up in August, the value of your CD may now be worth less than what you paid. Meaning, if you were to sell your CD on the secondary market, you could get $99,100. If rates went down in August and you sold your CD before it matures, the value might be $101,000. The key here is if your plan is to hold until maturity, it doesn’t matter much what your CD trades for on the secondary market because you’re holding it till 7/1/24. At maturity you collected your 5% and got 100% of your principal back.
With brokerage CDs some have a call feature much like a bond, where the bank can call the CD before it matures. You can avoid this by only looking at non-callable CDs.
Bank CDs don’t have any trading or management costs. Brokerage CDs can have a transaction cost or fall under an asset under management fee. Ask your brokerage firm if there any related costs before you buy.
If you’re unsure about which CD is best for your needs, reach out to your financial advisor- depending on your specific needs and time horizon, they will be able to help guide you to the right product for your needs.
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