Brokered CDs: Are They Worth Using?

A reader writes in, asking:

“I am retired and would like to put half of the bond side of my portfolio in CDs. My total retirement IRA is now at Fidelity. I also like to take the ‘lazier approach.’ So my question: What do you think about new or secondary market CDs from Fidelity?”

CDs purchased via a brokerage firm are known as “brokered CDs.” While brokered CDs can sometimes play a useful role in a portfolio, it’s important to understand that they’re meaningfully different from CDs purchased directly at a bank or credit union.

Interest Rate Risk

A major drawback of brokered CDs relative to directly-issued bank CDs is that brokered CDs cannot be redeemed with the issuer. Instead, they must be sold on the secondary market. As a result, they will experience the same sort of interest rate risk (i.e., price volatility) that other bonds do. That is, if you need to sell your brokered CD prior to maturity and rates have increased significantly since the time at which you bought the CD, it’s likely that you’re going to take a loss on the investment (due to the price decline and the bid/ask spread).

In contrast, it’s possible to find directly-issued bank CDs that have almost no interest rate risk because they have low penalties for early withdrawal.

Call Risk

A second potential drawback is that some brokered CDs are callable, meaning the bank has the option to “call” (i.e., force redemption of) the CD at certain times, stated in the CD contract’s terms. This becomes relevant in scenarios in which rates go down after you buy your CD. In such cases, the bank will often call the CD, forcing you to reinvest the money at the new lower rates (if you want to keep the money in some sort of fixed-income investment, that is).

When Can Brokered CDs Make Sense?

Despite their drawbacks, brokered CDs do have one advantage: convenience. Buying brokered CDs is less work than moving money from bank to bank as your CDs mature, in order to get the best rates around. As a result, even though it’s unlikely that you’ll find as good of a deal on brokered CDs as you could find on directly-issued bank CDs, non-callable brokered CDs can still be worth considering if:

1. You’re the type of investor who places somewhat more emphasis on convenience rather than absolute maximization of portfolio results,
2. The yield (after subtracting any relevant costs such as commissions) on the brokered CD in question is meaningfully greater than the yield on Treasury bonds with a similar duration, and
3. You stay under the FDIC limit.