Certificates of deposit (CDs) are a low-risk way to grow your money, offering stable, guarantee dreturns with the security of FDIC insurance. But not all CDs work the same way. Traditional bank CDs and brokered CDs have key differences that can impact your financial planning strategy.
In this article, we’ll break down how each type works and how they can help you build capital for retirement.
Bank CDs provide a fixed interest rate in exchange for locking in funds for a predetermined period. Purchasers of CDs often get higher interest rates for giving up access to their money until the CD matures.
This CD type is considered low-risk because of its locked-in rate and the fact that it’s insured up to $250,000 by the Federal Deposit Insurance Company (FDIC) for banks or the National Credit Union Administration (NCUA) for credit unions.
A bank CD is similar to a savings account, but the terms are more rigid. Unlike a savings deposit account that usually pays a lower interest rate, a bank CD requires you to keep your funds in the account for the CD’s full term.
Because you’re forgoing your liquidity to a certain extent — you can withdraw money if you’re willing to pay the penalty — bank CDs offer a better interest rate than traditional savings accounts.
These CD accounts usually have the following elements:
Say your bank or credit union offers a CD that requires a minimum deposit of $5,000 that pays4% APY compounded annually for a 12-month term, and the penalty for early withdrawal is three months’ interest. If you were to deposit the minimum amount, at the end of the term, you would accrue $200 interest ($5,000 x 4%). And if you were to withdraw the funds before the maturity date, the penalty would be $50 (1% of the principal).
Brokered CDs work similarly to bank CDs, but they are purchased through brokerage firms instead of banks or credit unions.
Like bank CDs, brokered CDs require a minimum deposit and have a set interest rate, compoundment period, and term. These accounts are also insured by the FDIC or NCUA, depending on their origin.
Unlike bank CDs, brokered CDs typically have no withdrawal rules.
Brokered CDs can be bought and sold on the secondary market, giving you the flexibility to exit your investment before maturity. While their value can fluctuate with market conditions, selling a brokered CD early allows you to avoid the fixed withdrawal penalties that come with traditional CDs.
Interestingly, banks can also sell brokered CDs, but these products are for brokerages, not consumers. Because brokerages are more likely to buy CDs in bulk, the bank can generate amore significant amount of money in a shorter time than it can by selling bank CDs.
While both brokered CDs and bank CDs offer a secure way to grow your savings, they differ in key ways that can impact your financial planning strategy. From how they’re purchased to their liquidity, here are four major differences to consider.
When it comes to certificates of deposit, there’s no perfect instrument for everyone. Consider the following advantages and disadvantages of each:
If your goal is to get a guaranteed rate and you expect to hold the CD to the end of its term, opt for a brokered CD because you’ll get a better interest rate. And if you don’t want to set up a brokerage account and prefer to deal directly with your bank, choose a bank CD.
Yes. Just like bank CDs, brokered CDs are insured up to the FDIC or NCUA limit — depending on the issuer.
A bank CD account is another name for a bank CD. The same applies to a brokered CD account.
This communication is for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice.
