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Brokerage Certificates of Deposit and IRAs


Fidelity's new Retirement Rewards American Express Card (see post) reminded me of a readers's email which described his experience with Fidelity's IRA and their brokerage CDs. For those with IRA's, it can be difficult to chase CD deals at banks and credit unions. It can be a hassle to do the trustee-to-trustee direct transfers and make sure it's completed before the offered rate expires. Brokerage CDs can help with this. With an IRA account at a discount brokerage like Fidelity, you can buy brokerage CDs from the IRA account. So there's no trustee-to-trustee transfers to worry about.

You can see the CD rates and terms available at Fidelity from their Certificates of Deposit page. The reader mentioned that Fidelity's CD rates haven't been that competitive, but they've started offering CDs from newly-born banks that used to be investment banks (Morgan Stanley, Goldman Sachs, etc.). These have been more competitive especially for terms of 5 to 7 years. I just checked new issue offerings as of 12/09/08, and the top rates for terms of 3 to 5 years range from 4% to 4.50%.

Some important details about these brokerage CDs as described by Fidelity:
  • All new issue CDs offered by Fidelity are fee-free
  • The CDs Fidelity offers come from multiple sources.
  • All CDs offered by Fidelity are FDIC-insured.
Here's an overview of Brokerage CDs and their advantages as provided by Fidelity:

Investing in brokerage CDs is similar to bank CDs, in that investors agree to place their funds with the issuing bank for the term of the CD, and the CD earns interest at a specified rate. At maturity (or earlier if there is a call option) the investors' funds plus interest will be returned. During the term of the CD your funds will earn an interest rate stated at the time of initial deposit.

Advantages of Brokerage CDs:
  • Liquidity - Brokerage CDs, like those offered by Fidelity Investments, may be traded on the secondary market and thus are generally more liquid than bank CDs. Although a brokerage CD will return an investor's principal at maturity, its value if sold prior to maturity will fluctuate based on size, time remaining before maturity and the level of interest rates.
  • Flexibility - A brokerage CD is portable and can be transferred from one brokerage firm to another, which allows the owner to consolidate assets at one firm.
CDs at Other Discount Brokerages:

Charles Schwab and Vanguard also offer brokerage CDs. Here are their CD pages along with a sample of the current CD rates:
  • Charles Schwab CDs: Rates as of 12/09/08: 3.80% APY for 12-24 month CDs, 4.05% APY for 31-42 month CDs
  • Vanguard CDs: Rates as of 12/09/08: 3.55% for 18-month, 4.35% for 3-year, 4.75% 5-year
Downsides of a Brokered Certificate of Depost

One downside with brokered CDs is that if the bank that holds the CD fails, there can be a long delay before you can get access to the money. The FDIC needs the brokers to provide detailed customer account information which can take more than a month. A reader in this post had a brokered CD through Schwab that was held by a bank that failed last Spring. He was told he would have to wait up to 6 weeks for his money.

Another downside can be early withdrawals. Instead of a fixed early withdrawal penalty, you have to sell it on the secondary market. As Fidelity describes, this can provide more liquidity. However, the value you can get in the secondary market may be much less than you had expected. A good description of this risk is described at this webpage. The webpage describes how the soundness of a bank can make a big difference in the value of the CD in the secondary market:
The bank issuing these CDs was rated 3 stars out of five by BauerFinancial, and it seems that the secondary market doesn't like this kind of bank. Yes, these CDs were FDIC insured. But apparently the market doesn't like long-term CDs from banks rated lower than four stars.

The author of this page mentioned he had bought a 10-year CD.

Thanks to the reader who emailed me info on Fidelity IRA and their CDs.

Edit 6/16/09: Updated Fidelity URL to their CD page.
Related Pages: CD rates, IRA rates
  |     |   Comment #1
This is an interesting article. I especially liked the details given by the person who bought Schwab CD and immediately lost some 6 plus percent.

So now, how are these CDs traded in the secondary market? Are they like stocks with small fixed commission? If so, it would make sense to invest in them up to FDIC limits (100k, not 250k because that limit could expire before the CD's term) and benefit from their low acquisition price.
  |     |   Comment #2
correction ... that was not a Schwab but a Vanguard CD

quote "I bought a total of $40,000 in 10-year CD's in January and February of 2003 from one of the best known, best respected security dealers in the country (Vanguard). "
  |     |   Comment #3
From that article, it sounds like there could be some good deals on the secondary market for brokered CDs from troubled, but FDIC insured banks. Anyone know a good place to look for those?
  |     |   Comment #4
Generally the penalty for breaking a CD at a bank is less than the cost of reselling a brokerage CD on the secondary market. It's not an issue if holding to maturity.

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