Bank CD vs. Brokered CD: Which one is better for me?
E*TRADE from Morgan Stanley
07/31/24
Thanks to their predictable returns, certificates of deposits (CDs) can be a great way to diversify a portfolio and earn a stable cashflow, in spite of market volatility and changes to the interest rate environment.
What is a bank CD and how does it work?
A bank CD is an account type which can be opened as individual or joint and it pays a fixed annual percentage yield (APY) for a set period of time.
- Bank CDs are purchased directly from a bank and begin earning interest immediately after funds are made available in the account, subject to federal funds availability rules.
- Interest from the CD will typically accrue and compound in the account unless the client opts for interest to be paid by check.
- When a bank CD matures at the end of the term, the principal and interest accrued will roll into the same term CD at the prevailing market rate. Alternatively, you may wish to withdraw the funds, which can be done within seven calendar days of maturity. If you miss the grace period to withdraw funds or need access to funds early, you may be subject to an early withdrawal penalty.
Are banks the only option to buy a CD?
No, there is another type of CD available for purchase called a brokered CD. Whereas a bank CD is purchased directly from a bank, and sits as its own bank account, brokered CDs must be purchased through a brokerage account similar to the process of purchasing a security. Brokered CDs may be purchased from a variety of issuing banks, offering a wide range of terms and interest rates.
Since brokered CDs sit in a brokerage account and behave similarly to securities, you are also able to sell a brokered CD on the secondary market ahead of maturity. However, this carries interest rate risk, as the market value of the CD may rise or fall depending on the interest rate environment. Brokered CDs earn simple interest, as opposed to bank CDs that allow interest to compound.
Bank CDs vs Brokered CDs: What’s the difference?
Choosing a CD will depend on many factors, including your personal financial goals, how much you’re looking to invest, and your risk tolerance. Here’s a closer look at how each type of CD works:
| Banks CDs | Brokered CDs | |
|---|---|---|
| How to purchase | Open a standalone bank account. | Through your brokerage account. |
| How long are the terms? | Bank CDs generally offer terms between 1-month and 5-years. | Brokered CDs can be purchased from a variety of banks offering clients a wider range of terms. |
| Yields | One rate offered at each term by the institution from which the CD is purchased. | Can purchase CDs from mulitple issuers at a wide range of rates. This market is typically more competitive and may offer higher yields as issuers compete on pricing and issuances. |
| Interest | Typically compounds, but typically can be paid out monthly or quarterly. |
Simple interest which can be paid out monthly, quarterly, semi-annually or annually. |
| FDIC insurance coverage1 | Bank CDs come with standard FDIC deposit insurance, up to $250,000 per depositor. |
Brokered CDs have the same $250,000 limits per account per bank. |
| Early withdrawal penalties | Yes. | There are no early withdrawal penalties associated with brokered CDs. They can be sold on the secondary market but are subject to price and liquidity fluctuation. |
| Interest rate structure | You will lock in a fixed rate when you purchase the CD. Interest compounds. |
The majority of brokered CDs yield a fixed rate of interest. There are also CDs that offer a variable interest rate structure, such as a zero-coupon, step-up rate, or floating CD. Brokered CDs pay a simple interest rate. |
| Survivor's options | Bank CDs can be redeemed penalty free if the account holder dies. |
Some brokered CDs come with a survivor’s option, which allows a survivor to redeem the CD at face value, regardless of the current market price, if the account holder dies. |
| Risks | The biggest risk with bank CDs is liquidity risk, since you’ll have to pay an early withdrawal penalty if you need to cash out before maturity. | Brokered CDs come with market risk, since if you sell before maturity, you may face a net loss if rates rise and you must sell at a discount. (You can mitigate this risk by holding the CD to maturity.) Some brokered CDs are callable. If you buy a callable brokered CD the issuer can buy it back from you before it matures. |
Bottom Line
- Buying bank CDs can be a simple and straightforward way to diversify your portfolio with an FDIC-insured account1, without monthly fees or minimums, that delivers a competitive rate with interest that compounds daily.
- Investors who are seeking higher interest rate options, a wider selection of term and yield structures, and a higher degree of overall FDIC coverage might consider investing in brokered CDs.
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