You could’ve bought a 12 month brokered Ally CD, on March 11, 2011 at ZionsDirect with a yield of 1.44%. That is 0.19% APY higher than buying the same term CD directly from Ally.
Definition: A brokered CD is a CD that is purchased by a broker (usually with a large sum) and then split up into smaller CDs and then offered to investors at above-average-rates. You must have a broker that offers brokered CDs to purchase one.
However, even though almost all brokered CDs are FDIC insured, they carry unique risks. You must know these risks and do your own due diligence before dipping your toes in the water.
Risk #1: Early withdrawal is not the same as with a regular bank CD, you or your broker have to sell your brokered CD on the secondary market to cash out. Your CD may not be worth as much as when you bought it, especially if the issuing bank has a below average Bauer Financial/Bankrate Star Rating. Selling your CD on the low volume secondary market will likely cost you more than a typical early withdrawal penalty on a bank CD.
Risk #2: Outliving your interest. Pick shorter term CDs. Some long term CDs have a 15 – 20 year maturity; because brokered CDs can’t be easily cashed out, make sure that you will live long enough to collect the interest payments on your CD. You can also sometimes designate a beneficiary.
Risk #3: Exceeding FDIC limits. If you already have deposits with a certain bank, make sure that if you buy a brokered CD issued by that same bank, you won’t exceed FDIC insurance limits (currently $250,000). And of course make sure the CD is FDIC insured.
Risk #4: Fees. Brokered CDs are usually purchased through a broker who will charge you either a flat fee or a percentage of the amount of the CD.
How to Buy a Brokered CD
There are many brokerage firms who offer CDs. A few include: TradeKing, Scottrade, and ZionsDirect. Simply contact your broker for details on purchasing CDs.
ZoinsDirect offers a slight spin on brokered CDs because it lets individuals bid on live CD auctions. Without having to login, you can view the current and archived CD auctions at the ZionsDirect Auctions site.
In order to purchase a CD through the ZionsDirect auctions, you need to have a ZionsDirect broker account. ZionsDirect charges a flat fee of $10.95 to buy a brokered CD.
Going back to the Ally CD example mentioned at the first of the article, let’s run a quick scenario to see whether it would be worth the extra risk to get the extra 0.19% APY.
1 Year CD direct from Ally Bank: 1.25% APY no Fee to Buy
Deposit: $10,000
Fees: None
Total Interest Earned: $125
1 Year Brokered CD by Ally Bank: 1.44% APY + $10.95 Fee
Purchased: $10,000
Fees: $10.95
Total Interest Earned: $133.05 ($144 – $10.95)
Difference: $8.05 ($133.05 – $125)
This illustrates the dent the fee puts into your return. The more you invest, the less significant the flat fee will be. The breakeven point in this example is $5750. Meaning if you invest less than $5750, the $10.95 fee will make your total yield/APY less than if you had purchased the bank CD.
Whew! After all that math, doesn’t it make you want to just stick to the simple, straight forward bank CDs? Make sure to keep an eye on the best CD rates on our chart – within the next year money market rates should start increasing. You can also make sure you’re keeping up with the rise in interest rates with a money market account.
By no means did this article cover all the risks associated with brokered CDs – make sure to do your own due diligence.
