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  3. Choose Wisely Between Brokered Vs Regular CD's - Could Be A $32,000 Difference On A $250K CD

Choose Wisely Between Brokered Vs Regular CD's - Could Be A $32,000 Difference On A $250K CD

Vernazza
  |     |   29 posts since 2022

In a falling interest rate environment, non-callable brokered CDs begin to shine. Generally, when a bank CD is broken and money is withdrawal early, a penalty worth months of interest is due. In stark contrast, with a non-callable, brokered CD, it can be sold for a premium right now.

Hypothetical real-life examples:

$250k, 5%, non-callable 5-year CD (Through Fidelity, Vanguard or Schwab)

• After 1 year, the CD pays about $12,500 interest.

• Can be sold immediately for a $11,750 premium over face value.

$250k, 5%, 5-year CD (Through Lafayette Federal Credit Union, which is always advertises in DA as a top 5 credit union with high rates)

• After 1 year, pays about $12,500 interest.

• 600 days early withdraw penalty, which is $20,547.99

Difference is over $32,000

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6


Answers
txFish1
  |     |   428 posts since 2023
I would never invest in a CD with a 600 day early withdrawal penalty For that matter I did not even know any financial institution had a withdrawal penalty that was that high. My concern with brokered CD's in a falling rate environment are the fact that the best I can get at Fidelity on a 1 year non callable was 4.1% as of last friday and I can still get over 5% on a 1 year going direct so on $250K that is about $2500 extra interest for the year, As much as I love the convenience of a brokerage account rates sure drop fast just at the hint of falling rates. YMMV
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13
Vernazza
  |     |   29 posts since 2022
Yes, 600 days is crazy. I just wanted to point that out for everyone since they are always on DA and promoted as delivering the highest total returns and best CD rates. It is a hugh dollar swing between Lafayette F.C.U. and a brokered CD if they were broken.

Below is a cut and paste from Lafayette F.C.U. website concerning CD disclosures.

9. Penalty — We may impose a penalty if you withdraw any of the principal prior to maturity. Penalties for the fixed-rate certificates and IRA
certificates will be imposed on amounts withdrawn whether dividends have been earned or not at the rate paid or payable for the term as follows:
• 7-month, 90 days of dividends (Not available on IRA Certificate)
• 1-year, 180 days of dividends
• 2-year, 270 days of dividends
• 3-year, 360 days of dividends
• 4-year, 480 days of dividends
• 5-year, 600 days of dividends
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3
Ltssharon
  |     |   426 posts since 2020
Neither would I. This year a relative needed a loan, and finally my roommate agreed to relocate and buy a condo together. Therefore, to accomplish these things, I had to early withdraw about 325k from various cds. That was bad enough even though my ewps were 6 months and under..
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2
P_D
  |     |   1,558 posts since 2020
Both Vernazza's observation and txFish1's observation are correct, but incomplete by themselves with respect to the decision between a direct or a brokered CD.

In order to complete the analysis you have to put the two together to see why it isn't necessarily a slam dunk either way.

In the current market environment, the interest premium in the direct market offsets the potential negative differential in the event that you have to liquidate before maturity.

So the question becomes whether to take the higher return of the direct CD by holding it to maturity in return for a lower return due to penalties and lack of market premium in the event you liquidate prior to maturity or visa versa. So the expected probability of liquidating early is a high impact factor in that analysis as is the expected direction and level of interest rates.

If you have planned so that liquidation before maturity is unlikely, it favors the direct CD even if the penalty is relatively significant.

There is also another factor (although likely with lower sensitivity) in that a 5% rate on a brokered CD is typically not the same as a 5% rate on a direct CD and in a falling rate environment the difference favors a direct CD since the brokered CD does not offer a guaranteed compounding rate.
 
Not a simple analysis to decide between the two.
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11
Ltssharon
  |     |   426 posts since 2020
The disadvantage of a brokered cd at schwab: Do not be fooled by the APY they show. Every time the cd earns interest, that interest is put in cash which does not earn interest. Therefore you are only earning simple interest, not apy. After the interest is put in cash, it is up to you to reinvest it somewhere. I cannot be bothered reinvesting small amounts repeatedly. Beware.
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5
Kirkland
  |     |   308 posts since 2014
Ltssharon,
You might consider transferring some of your brokered cd's to Vanguard. Your brokered cd interest would automatically go into the VMFXX (Vanguard Federal money market settlement fund), where it is currently accruing daily, interest rate of 4.58%. It would then be up to you, to periodically or whenever it was accumulated significant amount or whenever you could be bothered, to transfer it out to reinvest elsewhere.
Personally, I use accounts at Schwab and Vanguard. I push out all my Schwab (dividends and cd interest) to an FDIC insured liquid account. Since all money market rates have dropped everywhere, at Vanguard, I am pushing out less often, and only to FDIC insured liquid accounts earning more than 4.58%. There is no fee to partial transfer out one or multiple of your brokered cd's from Schwab to Vanguard.
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3
Ltssharon
  |     |   426 posts since 2020
I did as much as I could. Unfortunately I had convinced my son to buy a Schwab product (It could have been a treasury) that does the same thing. It is in a POD POA account which was a whole big deal to set up. And it is a 10 year if I recall correctly. THEN I learned about this limitation. But I will no longer be in Schwab myself for brokered treasuries or cds. Thank you.
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1
John19
  |     |   350 posts since 2022
You can get brokerage bonuses with brokered CDs as well. I got a $2500 bonus from Wells Fargo transferring only brokered CDs. In a rising rate environment though brokered CDs could be a problem that you will have to sell with no guarantee. I got about 60-40 bank CDs vs brokered CDs. I've sold a lot of CDs to buy ETFs and other CDs with longer maturities.
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3
w00d00w
  |     |   337 posts since 2012
imo brokered CDs are more like a bond than a CD. it appears to me that brokered CD rates are promptly responsive to changes in the treasury yield curve while direct CD rates lag. when treasury rates are quickly falling, the better rate deals are found for awhile in direct CDs. when treasury rates are rapidly rising, the better rate deals are often found for awhile in brokered CDs.

one way to greatly reduce the reinvestment risk associated with brokered CDs in a falling rate environment is to buy a discounted secondary market brokered CD with a very low coupon rate. the lower coupon rate means less interest paid, so less interest to reinvest. most of the yield in those type of brokered CDs comes from an increase in the discounted purchase price toward par as it approaches maturity, rather than interest paid.
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2
P_D
  |     |   1,558 posts since 2020
For those considering brokered CDs... Keep in mind that if you buy or sell on the secondary brokered CD market it can complicate your taxes. I would recommend consulting a CPA since the tax treatment is not necessarily trivial or without tax consequences that can affect your tax planning.
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4
w00d00w
  |     |   337 posts since 2012
i agree. from my perspective, brokered CDs are best held in a tax deferred account and preferably to maturity
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3
IGR
  |     |   539 posts since 2020
I must side with P_D.
When someone manufactures worst-case scenario hypothesizing real-life examples, then CHOOSE WISELY would be hypothesizing worst-case scenarios, like having to liquidate after one year
That way Wisdom is on the side of Direct CD which is over $300.00 ahead of Brokered one "After 1 year."
Different investments are chosen differently based on time horizon and risk tolerance.
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2
Hobbs_M
  |     |   34 posts since 2024
I agree with the posts; but If holding CDs in a tax deferred account to maturity the convenience of holding them in as few accounts as possible can be tempting if for nothing more than keeping up with maturity dates, income and FDIC compliance. If yields are close, I am willing to give up a little more in certain circumstances for saving time and convenience. 
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2
Hobbs_M
  |     |   34 posts since 2024
The access to multiple banks and FDIC insurance up to $5 million for a single owner does provide an option depending on the situation.
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2
Rightdx
  |     |   40 posts since 2022
Sure, you can sell your brokered CD for a profit, but then you will be sitting on a pile of cash.  You need to take into account "re-investment risk".  If you want to re-invest that cash you will have to accept a lower rate. The money you lose as a result of reinvesting at a lower rate will be approximately equal to the "profit" you made by selling your CD. So, it's a wash.
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2
Hobbs_M
  |     |   34 posts since 2024
Cds and bonds are conservative investments that I hold to maturity in either a tax deferred or regular account. For these accounts my priority is safety, protection of principle then convenience and growth. Time involvement just to ensure FDIC protection increased significantly following the FDIC rule changes so unless rate changes are impactful and with a larger financially secure company I will seek out the best convenient rate option and most likely forego constant changes.   Having said that I'm envious of people who can do it all and constantly secure the best rates!
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