What Is a Brokered CD?

I made my first foray into the world of brokered CDs late last year. Brokered CDs, or brokered certificates of deposit are an interesting fixed-income vehicle that are a little bit corporate bond and a little bit banking product.

Brokered CD-as-bond

I like to think of brokered CDs as an FDIC-insured bond. Like a bond, a brokered CD is an debt instrument on the part of the bank. When you purchase one, you're loaning the bank money for a specified term. It's one way banks raise money with which to make loans.

Like a bond, a brokered CD:

• pays simple interest;
• can be called (redeemed) before the maturity date; and
• can be sold on the secondary market.

Brokered CDs, as their name suggests, can only be purchased through a broker.

Brokered CD-as-bank product

As with bank CDs, brokered CD are insured up to FDIC limits (currently $250,000).¹ Honestly, there's no reason for this heading. FDIC insurance is the only similarity. 😄

How a brokered CD differs from a bank CD

With bank CDs, interest compounds. Each interest payment becomes part of the principal balance. This new balance is used to calculate the next period's interest payment.²

Bank CDs require that you park your money for the length of its term to receive its full value. You'll pay a penalty of a few months interest if you withdraw your money early.

Once your bank CD matures, both your principal and interest become available to withdraw without penalty.

With a brokered CD, you'll still need to park your cash for the term. But instead of compounding, interest payments get deposited as cash to your brokerage account. Since interest doesn't compound, brokered CDs usually offer higher rates than bank CDs.

If you need your cash before your CD matures, you can sell a brokered CD instead of withdrawing the principal. You don't pay a penalty, although you may end up selling at a loss. As part of the sale, you'll also receive any interest accrued since the last payment.

Less risky than corporate bonds, not as safe as Treasuries

I think brokered CDs hit a nice sweet spot between corporate bonds and U.S. Treasuries. Because they're FDIC-insured, if the issuer fails and can't repay your principal, that balance is still covered. Corporate bonds lack such protection.³

Our government is a hot mess, but it isn't a stupid one. If the United States government started to miss interest payments, it would shake the world's political, economic, and financial systems. The resulting shit show is pretty much what prevents us from defaulting on our debt. As a result, treasuries are widely-considered risk-free. Brokered CDs are a little riskier than that.

If you'd like to invest in brokered CDs, you'll need a brokerage account. ETrade, Schwab, Fidelity, and Merrill are just a few brokers that offer brokered CDs. Look for them in the Fixed income section of your broker's website.