Bank CDs vs. Brokered CDs: What's the Difference?
When market volatility ramps up, many investors consider certificates of deposit (CDs)—those seemingly mundane fixed income stalwarts available at your local bank. CDs can be an appealing option for investors who want to safely park their money, allow it to generate a bit of income, and walk away knowing their invested cash is generally FDIC insured up to $250,000.1
But did you know there's an alternative to bank CDs? Brokered CDs allow you access to a wider selection of CDs than you can typically find at a single bank. Furthermore, brokered CDs generally offer the same FDIC protection as CDs purchased directly from an issuing bank.
1. Differences in transaction
Where to buy: Bank CDs are purchased directly from a bank, while brokered CDs are purchased through a brokerage.
Purchase process: A bank CD is a deposit product, where you begin earning interest immediately upon deposit. With the brokered CD, you don't start earning interest until the settlement date.
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2. Differences in selection
Choice of issuer: If you go to your local bank to purchase CDs, you're limited to the one issuer. Brokered CDs, however, allow you to choose from banks all over the United States. And because FDIC insurance protects up to $250,000 per bank, it's a convenient way to invest more and maintain a higher level of insurance, since you are potentially spreading your portfolio of CDs across multiple FDIC-insured banks.
Choice of yield and terms: In general, the wider the range of CD products, the wider your selection of maturities, yields, and, of course, risks. If you shop carefully, you might be able to find more suitable terms and yields by virtue of having a wider array of choices.
3. Differences in costs
Transaction costs: Brokered CDs may cost more to obtain than bank CDs. The difference depends on the specific brokerage and the services it offers. Some brokerages may simply add a commission fee directly to your CD, while others may charge additional fees for asset management, financial planning, and more. But higher transaction costs for a brokered CD may reflect the potential benefits of a wider and more diverse offering. If a brokerage does most of the aggregating and vetting, provides you with access to multiple banks, shops around for competitive rates, and assists you with renewals, a reasonable fee might be worthwhile.
4. Potential benefits of brokered CDs
Brokered CDs offer some of the same benefits as bank CDs: they are steady and predictable, they usually provide a better interest rate of return than a savings account, and they generally offer FDIC insurance.1 But there are some areas where brokered CDs offer some specific advantages.
Broad selection and flexibility: When you buy a CD from a brokerage, you have the option of holding that CD in any account type offered by that firm, including a brokerage account where you hold other investments. And brokers will generally offer them in a wide range of maturities, from one month to as long as 30 years. If you buy a CD directly from a bank, you might have more limited options, depending on the bank's offerings.
Increase your overall FDIC coverage: Current FDIC coverage insures each individual bank up to $250,000 per depositor.1 So, if you purchase several brokered CDs from different banks, you generally get the full FDIC coverage from each bank.
Creating CD ladders: It can be easier to create CD ladders with brokered CDs than with bank-issued CDs due to the wider range of CDs offered by a broker. For example, a single brokerage firm will generally offer a sufficiently wide range of maturity dates to build a one-, two-, or five-year ladder that meets an investor's goals. Building a ladder with bank CDs would require going to multiple individual banks to assess their offerings.
5. Potential risks with brokered CDs
Market risk: Brokered CDs may often be sold through a secondary market. And most brokered CDs, unlike bank CDs, do not have early redemption fees. But, depending on market conditions, there is no guarantee that there will be a market for your CD when you want to sell. And selling your CD on the open market exposes you to fluctuating prices and the bid/ask spread—the difference between the highest buyer's price and the lowest seller's price. You might want to sell your CD for a specific price, but there might not be bidders at that price. For example, if interest rates have risen since you purchased your brokered CD, there may be less demand for your lower-yielding CD. On the other hand, if interest rates have gone lower, you may be able to sell your higher-yielding CD for a profit. It all depends on market conditions that are subject to change.
Call risk: For callable CDs, the issuing bank can redeem, or "call," your CD before its maturity date. Essentially, they buy it back from you early before it fully matures, returning your principal and any interest you earned up to the date of the call. But this can be true of both bank CDs and brokered CDs. The primary risk for the investor is that the issuer will exercise a call option at an unfavorable time, such as when interest rates decline. Wherever you purchase a CD, you should be aware of whether it's callable or not, and if so, what the terms are.
Bottom line
Knowing both the pros and cons of bank CDs versus brokered CDs can help an investor make an informed decision about which type of CD best aligns with their investing goals and objectives. As always, it's important for investors to do their own research and consult with a financial professional, when necessary, to discuss their particular situation.
1 Funds deposited at an FDIC-insured institution are insured, in aggregate, up to $250,000 per depositor, per insured institution based upon account type by the FDIC. The FDIC considers any other deposits you may have with an issuing bank. CDs you purchase from a particular bank are aggregated with any other deposits you may have with the issuing bank for determining FDIC insurance coverage (i.e., if you already have deposits of $250,000 with a bank, newly purchased CDs from the same bank in the same ownership category may not be covered). Because the deposit insurance rules are complex, you may want to use FDIC's online tool, Electronic Deposit Insurance Estimator (EDIE), to estimate your total coverage at any particular bank.
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This material is intended for general informational and educational purposes only. This should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned are not suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decisions.
All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Investing involves risk, including loss of principal.
This information is not a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager, Estate Attorney) to help answer questions about specific situations or needs prior to taking any action based upon this information. Certain information presented herein may be subject to change. The information or material contained in this document may not be copied, assigned, transferred, disclosed or utilized without the express written approval of Schwab.
Schwab will usually receive a placement fee from the issuing institution in connection with the purchase of a CD. There may be transaction costs and market losses associated with selling a CD before it matures.
Please visit the Schwab CD OneSource® page for a list of insured financial institutions that offer CDs through Schwab.
A bond ladder, depending on the types and amount of securities within the ladder, may not ensure adequate diversification of your investment portfolio. This potential lack of diversification may result in heightened volatility of the value of your portfolio. As compared to other fixed income products and strategies, engaging in a bond ladder strategy may potentially result in future reinvestment at lower interest rates and may necessitate higher minimum investments to maintain cost-effectiveness. Evaluate whether a bond ladder and the securities held within it are consistent with your investment objective, risk tolerance and financial circumstances.