Note: This article is part of our Basic Banking series, designed to provide new savers with the key skills to save smarter.
Certificates of deposit (CD) are a great option if you’re looking for a secure vehicle for saving money, whether for a big goal like retirement or a long vacation, or just to park your emergency fund. As you research your CD options, you may come across terms like “bank CD” or “brokered CD” that seem puzzling.
There are important differences between a traditional bank CD and a brokered CD that you need to understand before you invest. As their names suggest, you obtain a bank CDs from a bank or a credit union, while you buy a brokered CD from a brokerage like Charles Schwab or TD Ameritrade.
The differences don’t stop there, however. While these two products are technically both certificates of deposit, the way they behave in practice is different, and these key differences can help or hinder you from reaching your financial goals.
What is a brokered CD?
A brokered CD is a certificate of deposit that you buy (and sell) via a brokerage firm. The brokerage is a middleman in the transaction: Brokerages buy CDs in bulk from a variety of banks, attempting to negotiate higher interest rates for their clients, and then turn around and sell those CDs to their clients.
The hallmark of a CD that is brokered is liquidity: Because you can buy and sell these CDs at will, your funds are not bound by the term of the underlying certificate. And there are no interest penalties for selling before the CD’s term is up. Brokers charge a trading fee for each purchase or sale transaction, so this greater liquidity is not free of costs. You have the choice to buy either “new issue” brokered CDs that have just been opened, or you can buy the equivalent of a used brokered CD that has already partially completed its term.
If you need to access your money early, such as in the event of an emergency, you can sell your brokered CD via the brokerage. Sometimes, that’s easier said than done.
“The secondary CD market has been known to be ‘thin’ in that you may not have many buyers interested in your CD that you’re trying to sell,” says Ken Tumin, founder and editor of DepositAccounts. Generally you won’t have any problem selling your CD if you need to do so, but a thin market can affect the price you get for it.
If the CD isn’t issuing much interest or if the CD is from a bank with poor financial health, this can drive down the price so that you’ll be selling the CD at a loss, sometimes significantly so. On the flipside, if the CD is offering higher rates than new issues, you may be able to sell it for a profit.
Interest payments from these CDs do not compound, like they do for bank CDs. This means you may lose out on some returns, because your interest payments are generally deposited into low-yield brokerage accounts. Also, CDs that are brokered generally don’t automatically roll over into another CD, although some brokerages do allow for this option. Once they mature, the principal will be deposited into your general investing account, and you must choose what to do with it next.
What is a bank CD?
Bank CDs are purchased directly from a bank, which is why these CDs are also sometimes known as “direct CDs.” There are no trading fees, all you need is enough money to meet your CD of choice’s minimum deposit requirements. In most cases, this is around $1,000, although there is a lot of wiggle room around this number if you shop around with different banks.
There is no secondary market for bank CDs: You can’t buy or sell them. You will be the sole owner for the term of the CD. Instead, if you need to access your money early, you’ll pay an early withdrawal penalty fee to cash in the CD, typically equal to a few months’ worth of interest payments. The penalty is determined according to a pre-set schedule, depending on the length of your CD’s term.
Bank CDs generally offer the option to let interest payments compound. This means that the interest you earn on the CDs is calculated monthly and deposited back into the CD account itself to earn even more interest with each passing month. Some also let you receive regular interest earning payments, and skip the power of compounding.
When bank CDs mature, they generally roll over into a new CD of the same type. This makes it easy if you have something like a CD ladder strategy in place, because your money will constantly be invested without any input from you. You’ll also get a short grace period of one to two weeks after the CD renews to withdraw your money penalty-free if you need it.
Brokered CD vs. bank CD: What’s the difference?
|Brokered CD||Bank CD|
|Available from brokers||Available from banks|
|Must pay trading fee to purchase||No trading fees to purchase|
|Term lengths from 3 months to 20 years||Term lengths from 3 months to 10 years|
|Must sell the CD on the secondary market if you need to withdraw the money early||Must pay an early withdrawal penalty if you need the money early|
|Interest does not compound||Interest does compound|
|Multiple CDs can be managed from the same account||Each CD must be managed individually|
|CD does not roll over into a new CD at maturity||CD does roll over into a new CD at maturity|
What are the benefits of a brokered CD?
With the risks of a brokered CD, you might wonder why anyone would want to deal with brokered CDs in the first place. The answer is simple: simplicity, especially if you’re putting a large amount of your portfolio into CDs.
“A major attraction of brokered CDs over direct CDs is convenience. You can buy and sell brokered CDs that are issued from many different banks from one trading platform at one brokerage firm. You don’t have to open and close accounts at different banks,” says Tumin. “The convenience factor is even more important when you hold CDs inside IRAs.”
Consider insurance as well. Your total deposits at individual banks are only covered up to $250,000. For things like retirement savings, this may not be enough, forcing you to open multiple IRA CDs at multiple banks. But if you opt for the brokered CD route, you can easily open multiple IRA CDs from multiple banks, ensuring that you stay under the $250,000 threshold for each individual bank, all while keeping your accounts in one tidy place with one login.
“Since there is a trading market for brokered CDs and they are comparable to Treasury notes as a very safe fixed-income investment, their rates tend to follow Treasury note yields,” says Tumin. This leads to an interesting side effect: brokered CDs can track interest rate changes faster than bank CDs can. Depending on whether interest rates are rising or falling, and where brokered CD and bank CD interest rates start from, a savvy investor can take advantage of these opportunities to earn even more interest.
Questions to ask yourself when considering a CD
Choosing between a brokered CD or a bank CD involves making key decisions about your investing needs and available options. Answering the following questions can help make the decision between these two CD options:
- How likely are you to need the money before the CD matures? If you need the money early, are you willing to sell a CD for a potential loss?
- Do you need the convenience of a platform for investing in many CDs, or do you only want to open a few CDs?
- Do you want the convenience of CDs that automatically renew when they mature?
- Do you only care about whether you get the highest CD interest rate, regardless of whether it comes from?
If you anticipate needing to withdraw funds from a CD before its term is over, you should take a closer look at brokered CDs. Also, no-penalty CDs could be an option worth looking at.
If you want to build a CD ladder or only invest in one or two CDs, you should look at bank CDs. If you like the option of investing in many CDs, with multiple term lengths, with lots of options, check out brokered CDs.
If you want to “set it and forget it,” and invest money in a CD that you won’t be withdrawing for a long time, than a bank CD is for you. They roll over automatically, while brokered CDs require more of your attention.
Compare both bank CDs and brokered CDs. If you are most interested in the highest rate, you should check out both options.
The bottom line
Brokered CDs are not inherently better than bank CDs, and vice versa. It all depends on what your goals are. If you’re looking to invest in many CDs, consider whether brokered CDs are right for you. If you only want to open a few CDs, bank CDs might be more appropriate. If all you care about is the highest interest rate possible, take a look at both choices. If you made your decision carefully, CDs can be a great tool to help you build your wealth, regardless of the source.