The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to inform investors about the potential risks of some certificate of deposit accounts (CDs). When looking for a low-risk investment for their hard-earned cash, many investors turn to CDs. In combination with recent market volatility, advertisements for CDs with attractive yields have generated considerable interest. While CDs issued by insured banks are federally insured and generally considered safe, some CDs are more complex and may carry more risk. We discuss these risks below and provide some tips for investors to consider before investing their money in these CDs.
The Basics of CDs
A CD is a special type of deposit account with a bank that typically offers a higher rate of interest than a regular savings account. When you purchase a CD directly from a bank, you invest a fixed sum of money for a fixed period – generally anywhere from six months to five years – and, in exchange, the issuing bank pays you interest, typically at regular intervals. When you cash in or redeem your CD, you receive the money you originally invested plus any accrued interest. If you redeem your CD before it matures, the terms of the CD may require you to pay an “early withdrawal” penalty or forfeit a portion of the interest you earned.
Unlike other investments, CDs issued by federally insured banks feature insurance coverage that protects customers up to a specified amount in the event of the issuing bank’s failure. The Federal Deposit Insurance Corporation (FDIC) provides this deposit insurance (federal deposit insurance) for deposit accounts at FDIC-insured banks. This insurance generally applies to products such as checking and savings accounts, money market deposit accounts, and CDs. Customers are insured up to $250,000 per customer, per insured bank, for each account ownership category. Common examples of account ownership categories include individual accounts, joint accounts, and certain trust accounts.
What are Brokered CDs?
Although most individuals purchase CDs directly from banks, many SEC-registered brokerage firms and unregistered independent salespeople also offer CDs. These individuals and entities – known as “deposit brokers” – can sometimes negotiate a higher rate of interest for a CD by promising to bring a certain amount of deposits to the institution. The deposit broker can then offer these “brokered CDs” to their customers. Brokered CDs are generally issued by banks via a “master CD” to the deposit broker, who in turn offers to sell interests in the master CD to individual customers.
Brokered CDs typically are more complex and may carry more risks than CDs offered directly by banks. In addition, since brokered CDs are sold through intermediaries, you should consider whether to take extra steps to help protect yourself from fraud. The following additional tips can help you evaluate a brokered CD:
Check Out the Background of the Deposit Broker
Although many deposit brokers are registered with the SEC as broker-dealers, other deposit brokers do not go through any licensing or certification procedures to act as deposit brokers; some deposit brokers are not state or federal agency licensed, examined, or approved. You should always check whether your deposit broker or the company they work for has a history of complaints or fraud.
- Many deposit brokers are affiliated with registered investment professionals. You can check out the background of most registered investment professionals quickly using Investor.gov. Your state securities regulator may also have additional information on investment professionals.
- To research the background of a deposit broker who is not affiliated with a registered investment firm, start by contacting your state’s consumer protection office.
You should continue researching until you are comfortable with the deposit broker. If you have concerns about a deposit broker, you should consider purchasing a CD through another deposit broker or buying one directly from a bank.
Identify the Issuer and Check Deposit Insurance Coverage and Limits
Make sure you know which bank issued your CD and verify that it is FDIC insured if you are seeking FDIC insurance. In other words, confirm in writing where the deposit broker plans to deposit your money. You can verify whether a bank is insured by the FDIC through the FDIC’s BankFind tool at BankFind Suite (fdic.gov).
Your deposit broker may plan to put your money in a bank where you already have CDs or other deposits. As discussed earlier, federal deposit insurance is limited to a total aggregate amount of $250,000 for each depositor per account ownership category in each bank. If the money you put into your brokered CD pushes your total deposits in an account ownership category at a bank over the $250,000 federal deposit insurance limit, you are at risk of having uninsured funds and may lose money if the insured bank fails.
Further, you should confirm with your deposit broker that the money is placed in a properly titled deposit account at the insured bank. This is important because, unlike traditional bank CDs, brokered CDs are sometimes held by a group of unrelated investors. Instead of owning the entire CD, each investor owns a piece. This may make it harder for you to submit an FDIC insurance claim in the event of a bank failure.
Good account records by your deposit broker and compliance with other FDIC requirements, can help ensure your CD will be FDIC-insured, and, in the event of a bank failure, you will be paid quickly.
Confirm with your deposit broker how your CD is held and make sure that your deposit broker describes the way that the CD is titled to you, in writing (for example, in a periodic statement or other document). If several investors own the CD, the deposit broker will probably not list each person’s name in the title. But you should make sure that the account records reflect that the deposit broker is merely acting as an agent or custodian for you and the other owners, and does not have any ownership rights over the CD (for example, “XYZ Brokerage as Custodian for Customers”). This will help to ensure that your portion of the CD qualifies for full federal deposit insurance coverage.
Understand Sales Fees, Maturity Dates, and Callability
Your deposit broker may charge you a fee to sell your brokered CD in the secondary market. This could reduce any investment return of your brokered CD, or increase your losses. Before buying a brokered CD, make sure you understand any sales fees your deposit broker may charge to sell your brokered CD prior to maturity in the secondary market.
A CD’s maturity date is the date when the CD’s term ends, and the bank returns your principal and interest to you. Brokered CDs typically offer a greater variety of maturity dates than CDs purchased directly from a bank. Maturity dates for brokered CDs may range from six months to thirty years. As with CDs purchased directly from a bank, make sure you know the exact maturity date of a brokered CD. As discussed in more depth below, there may be consequences of withdrawing your money early.
Brokered CDs may have call features. Call features give the bank issuing the brokered CD the right, after a set period of time, to redeem or “call” the brokered CD before its maturity date. These call features do not give you, the brokered CD holder, the same right. If a call occurs, you will receive all your principal and any interest you have earned on the brokered CD up until the date of the call.
Interest Rates: Simple vs. Compound Interest
Make sure you understand when and how a brokered CD will pay you interest. A brokered CD usually pays interest on regular intervals (for example, monthly, quarterly, or semi-annually). However, unlike CDs purchased directly from a bank, brokered CDs generally pay simple interest rather than compound interest.
Simple interest is only based on the original amount you placed in the CD, while compound interest is based on the original amount you placed in the CD plus any accumulated interest you receive though the CD’s maturity date. Instead of allowing interest to accumulate and compound inside the CD, brokered CDs pay interest out to the CD holder in cash at a specified interval. To earn interest on a brokered CD’s interest payments, you must reinvest these funds in another account.
Simple vs Compound Interest Example:
The following example shows the difference in how $1000 grows at an annual interest rate of 5% under simple and compound interest over a 5-year period.
|Value End of Year 1
|Value End of Year 2
|Value End of Year 3
|Value End of Year 4
|Value End of Year 5
After the first year both accounts receive an interest payment of $50 (5% x $1000) and have a total value of $1050. With simple interest, you only earn annual interest on $1000 each year. However, with compound interest, you earn annual interest on $1000, and the interest accumulated from previous years. So, in the example above instead of earning interest on just $1000 in year 2, you earn interest on $1050 which gives you an extra $2.50 of interest at the end of year 2. This compounding effect continues through year 5 and results in an extra $26.28 of interest after 5 years. For more information on how compound interest works check out our Compound Interest Calculator | Investor.gov.
Withdrawing Your Money Early
IMPORTANT: Brokered CDs can generally be sold at any time through a secondary market. However, depending on market conditions, some brokered CDs may not have a secondary market. This will require you to hold the CD until it matures, is called (if possible), or market conditions change to allow for a secondary market sale.
Brokered CDs generally do not have early withdrawal penalties like CDs purchased directly from a bank. You can generally sell brokered CDs at any time in a secondary market, subject to market conditions. However, if you sell a brokered CD in the secondary market, you may lose some of your original investment due to a change in the market price of the CD.
If interest rates have risen since you purchased your brokered CD, there may be less demand for your lower-yielding CD. That means you would have to sell the CD at a discount and lose some of your original deposit. On the other hand, if interest rates have fallen since you purchased your brokered CD, you may be able to sell your brokered CD for a profit since it features a higher interest rate.
If you have questions about a brokered CD, you should contact the regulator that oversees the bank that issued the CD. And, to the extent you have concerns with or questions about a deposit broker (discussed above) or other intermediary, we would also like to hear from you.
You can send us your complaint using our online complaint form at https://www.sec.gov/oiea/Complaint.html. You can also reach us by regular mail at:
U.S. Securities and Exchange Commission
Office of Investor Education and Advocacy
100 F Street, N.E.
Washington, D.C. 20549-0213
You could also contact the financial regulator that oversees the bank that issued the CD:
The Board of Governors of the Federal Reserve System oversees state-chartered banks and trust companies that belong to the Federal Reserve System.
The Federal Deposit Insurance Corporation is the primary regulator of state-chartered banks and savings associations that do not belong to the Federal Reserve System and the back-up supervisor for the remaining insured banks and savings associations.
The Office of the Controller of the Currency regulates banks that have the word “National” in or the letters “N.A.” after their names.
The National Credit Union Administration regulates federally charted credit unions.
For additional investor education information, see the SEC’s website for individual investors, Investor.gov.