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The HSA Report Card Blog

HSA Savers! Consider Earning Safe Returns With Brokered CDs

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HSA Savers and conservative investors should consider brokered CDs to earn moderate, but safe returns. Savers now have free access to brokered CDs thanks to Fidelity and Lively. These two administrators do not charge HSA participants an investment fee to access a brokerage account.

What Are Brokered CDs?

Most people think of going to the bank or credit union and getting a CD. In such situations, you have access only to the products and rates offered by that particular financial institution. If you are looking for a wider range of offerings, you can actually go to a brokerage and find CDs. Brokered CDs usually have higher interest rates than CDs you find through local banks. This is because brokerages have access to CDs from a wide variety of banks in a number of locations.

Primary Market

When you buy a CD or bond on the primary market, you're buying a security that's just been created, commonly referred to as a "new-issue." It's like buying a new car. You're the original owner. Proceeds from your purchase go to the issuer of the security, such as a bank for CDs and corporation or government agency for bonds.

Brokered CDs can be bought at new issue through online brokerage firms like Fidelity, TD Ameritrade and Schwab. The new-issued brokered CDs will usually start at $1,000 and be available in $1,000 increments.

Secondary Market

When you buy or sell a CD or bond on the secondary market, you're transacting with another market participant, not the issuing company or agency. It's like buying a used car. If you're selling a security, you get the proceeds; if you're buying one, proceeds go to the seller.

Brokered CDs can be bought and sold on the secondary market. If you decide to withdraw your money early from a brokered CD, you are not charged a prepayment penalty; instead, the brokerage tries to sell your CD on the secondary market. However, it is important to note that, while early withdrawal penalties won’t apply, you could still lose money.

On the secondary market, CDs are often bought and sold based on demand from the market. If your CD offers a higher rate than new CDs, then you will probably find buyers for it, and be able to get at least face value for the CD. However, if interests are moving higher, investors won’t want to pay as much for your CD, with its lower yields. As a result, you can actually lose money on CDs when you sell on the secondary market, since you may not get face value for your CD.

Brokered CDs vs Traditional Bank CDs

Brokered CDs are similar to CDs at a bank, but they are different in the way that they are bought and sold. If you have to terminate your bank CD early, you let your bank know and you’ll likely forfeit some interest as an early withdrawal penalty. With a brokered CD, you sell the CD on the secondary market – like you would with a stock, bond or mutual fund. So with a brokered CD, you’re not closing it out; rather, you’re selling it to another party.

Buying CDs via a brokerage account opens up your investment choices to a wide universe of banks. Contrast this with a situation where you walk into a bank and ask about CDs – they’re only offering their CDs. If you use brokered CDs, you’ll likely be exposed to CDs from a variety of banks.

Usually, brokered CDs are trickier and riskier than bank CDs. For example, Brokered CDs are often callable. This means that banks can recall the CD within a certain time period. You get your principal back, and any interest you have earned, but the CD is reclaimed by the bank. This usually happens when interest rates are dropping. That way the bank can call the CD with the higher yield, and issue new CDs with low yields that reflect current rates. When you get a brokered CD, make sure you understand whether or not a call is possible, and the terms of the call. Traditional bank CDs are rarely callable.

When shopping for brokered CDs, skip the ones that are callable. They may offer slightly higher yields, but they allow the bank to terminate the CD early, meaning you may not enjoy that yield for very long.
— Allan Roth, founder of Wealth Logic

Associated Risks

A major risk of brokered CDs is market risk. It’s the risk that you’ll sell your CD on the secondary market for less than you paid. Ideally, you’ll keep your CDs until maturity and eliminate this risk. However, life is uncertain, and sometimes we need a change of plans. As previously mentioned, CDs can act like bonds – if interest rates rise, buyers in the secondary market may not want to pay face value to help you get out.

Another risk of brokered CDs is credit risk. Since CDs are a debt instruments, there is a risk that the issuing institution will default. FDIC insurance helps mitigate that risk. You should make sure that any issuing banks are safe and FDIC-insured.

Safety and Convenience

The majority of brokered CDs are FDIC-Insured up to $250,000. Brokered CDs offer return of principal and interest, insured up to FDIC limits as long as you keep your money in the CD for the term specified by the financial institution.

You can pick CDs that best match your preferred “return of liquidity” time frames. You have the option to invest in brokered CDs that mature in 3 months, 9 months, 12 months or several years. In a rising interest rate environment its best to invest in CDs with short maturities. By investing in short-term CDs, an investor has the ability to reinvest funds as rates go up.

Disclaimer

TheHSAReportCard.com exists for educational purposes only, and the materials and information contained herein are for general informational purposes only. None of the information provided in the website is intended as investment, tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement, recommendation or sponsorship of any company, security, or fund. The information on the website should not be relied upon for purposes of transacting securities or other investments.

Noe Padilla