Q: What are the differences between a brokered CD and a bank CD?
A: A certificate of deposit is a type of bond that has a stated maturity and coupon payment. Most CDs offer a fixed interest rate, and maturities can range from one month to 30 years. CDs have insurance from the Federal Deposit Insurance Corporation (FDIC) up to $250,000, including principal and interest, per account title. The following is an overview of the differences between a bank CD and a brokered CD:
| Consideration | Bank CD | Brokered CD |
| How are rates determined? | Administered rates | Market-driven rates |
| Early withdrawal penalties? | Can be significant | No penalties |
| Price risk? | No | Yes |
| Can the CD be traded or transferred another party? | Can be transferred without penalties to beneficiaries in event of death of owner(s) | Trade on the open market |
How rates are determined
Brokered CDs rates are market driven. They can be traded like other bonds. Bank CD rates are determined through an administered rate that may not reflect current market rates. When banks offer rates that are out of balance with competing institutions, this could signal that a bank needs funds to manage its assets and liabilities, or that it may be trying to attract new deposits. Thus, the bank may be willing to pay more than the current market rate to gain funds.
The liquidity and price risk
Bank CDs could incur a penalty if redeemed prior to maturity. There is no price fluctuation. Brokered CDs can be sold in the secondary market prior to maturity and fluctuate in value according to market rates. If rates are higher than the coupon rate, the CD could sell at less than par. If rates are lower, they could sell above par and trigger a tax event if held in a taxable account.
The convenience of brokered CDs
Brokered CDs can be bought from different issuers for the same account through the primary and secondary market to ensure FDIC coverage, and they can be held with a custodian. Bank CDs have to be bought and held through that specific institution. If dealing with more than $250,000, several accounts need to be opened at several banks.
Considerations before making an investment decision
Before deciding whether CDs are appropriate in your overall investment strategy, it is important to confirm 1) maturity, 2) rate and 3) any additional features, such as calls. An advisor can help you consider the different components of a CD. It is prudent to investigate any investment vehicle before including it in your portfolio, and CDs are no exception.
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