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Check your brokerage when looking for CDs

By Laura Bruce

The next time you head for the bank to buy a certificate of deposit, you may want to look at the options offered by a brokerage.

Many investors don't realize that brokerages sell CDs. CDs aren't the most popular investment offered by brokerages, and you may have to dig deep on the company's Web site to find its CD offerings.

Some brokerages came under fire from regulators for allegedly misleading investors about callable CDs. As a result, some investors may think all brokerage CDs are callable.

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The fact is many brokerages sell a full line of noncallable CDs at competitive rates for a wide variety of maturities.

Karen Liebsch of St. Louis-based Edward Jones says her company averages about 75 to 80 CD offerings. Fidelity listed about 20 during a recent visit to its Web site. The number of CDs offered by your brokerage may be larger or smaller, but seeing them all on one site or talking with one representative could save you a lot of phone calls or Web surfing.

"We don't have CDs listed on our Web site," Liebsch says. "Customers would speak with their investment representative, who has a full range of CDs. They range from three months to 10 years. We don't sell callable CDs."

Jason Flurry, a certified financial planner and president of Legacy Partners Financial Group, Woodstock, Ga., says there are several benefits and several drawbacks to buying CDs from brokerages. You'll have to decide if one side outweighs the other when it comes to your investment needs.

Insured and centralized

One of the biggest benefits is you can buy CDs from several banks without opening a new account at each bank. In addition to cutting down on paperwork at tax time, Flurry says it can also be important when it comes to FDIC coverage for your deposits.

"You could have $300,000 worth of CDs in your one brokerage account, but because the money's in three different banks every penny of it is FDIC insured," Flurry says.

To understand how your deposits are insured at a bank, see this report.

Another benefit of brokerage CDs, according to Flurry, is that while the broker receives a commission for selling you a CD, it doesn't come out of your pocket.

"The commission is negotiated between the brokerage and the bank," says Flurry. "If you wanted a $50,000 CD, you'd deposit $50,000 and earn interest on it, and you'd get all of your money back at the end of the term."

Brokerages like to tout the liquidity of their CDs.

"With a bank you have an early withdrawal penalty, with brokerages there is no penalty," says Mary Jane Brinkman, fixed income manager at Scottrade.

"You sell your CD on the secondary market and receive either more, less or equal to what you originally paid for it, depending on market conditions."

When it comes to interest rates, you'll have to do some homework. Brokerage interest rates are competitive and often higher than what you'll find locally, but you shouldn't expect to squeeze a few extra basis points out of a broker the way you sometimes can with a banker.

"Sometimes you can go to your bank and say the bank across the street is offering 10 basis points more, and they'll give it to you," says Flurry. "Rates at a brokerage aren't negotiable. You don't get any special deals for being over 55, depositing a large sum of money or doing a lot of business with a brokerage. Rates are what they are. They don't care if you've got $10,000 or $10 million."

Jack Ablin, chief investment officer at Harris Direct says brokerage CDs are extremely competitive, but it pays for consumers to comparison shop with banks in their neighborhood where they might have a little more influence.

"Banks can be looking for a lot of different things. They're looking for funding, but they're also looking for relationships. They could encourage consumers by offering teaser rates."

CD creativity

Banks have grown more creative with CDs. Many offer more than the traditional fixed-rate CD. There are CDs that allow you to step up to a higher interest rate during the term of the CD; others may let you make a penalty-free withdrawal.

Brokerages offer options, too.

"There's a lot more to choose from than just straight bullets (noncallable CDs)," says Brinkman. "There are callables, zeros and secondaries. There are different maturities and coupon (interest payment) frequencies where you can possibly get higher yields."

A callable CD usually offers a higher rate of interest because the issuer reserves the right to redeem the CD before maturity. The CD would be redeemed early if interest rates fell because the CD could be reissued at a lower rate. Most callable CDs come with a one-year call protection period during which the CD can't be called, and the interest rate is guaranteed. If the issuer doesn't call the CD, the customer continues receiving the higher yield for the remainder of the term.

If you buy a callable, make sure you understand the difference between the call period and the maturity date. Also, as with any CD, be sure the term (the length of time before the CD matures) is appropriate for your budget.

A zero is a CD that doesn't have a coupon or interest that's paid over the term of the CD. Instead, the CD sells at a discount to face value, and when it matures you get the full face value. You might buy a $10,000, five-year CD for $8,500. After five years, you receive $10,000.

A drawback to zeros is that the IRS expects you to pay tax on the interest as it accrues each year. Since it's phantom interest, you'll have to come up with the cash unless the CD is in a tax-deferred account.

Secondaries are CDs you buy from the secondary market. Just as you could sell your brokerage CD by going to the secondary market, you could also purchase one. If someone sold a five-year CD after holding it for just three years, you could buy the CD, hold it for the remaining two years and earn the five-year interest rate.

The catch is you'd have to pay a premium for getting that five-year interest rate on what amounts to a two-year CD. The premium would be built into the principal. In other words, you might pay $10,200 for a $10,000 CD. You'd have to rely on your broker or get out your calculator to see if you would get a better yield than what is currently offered on two-year CDs.

If stashing a CD certificate in your safe-deposit box or under the mattress is important to you, a brokerage won't be very accommodating. You'll get a confirmation of the purchase, but everything is done electronically.

-- Posted: Sept. 16, 2002

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