The first thing I always tell clients is when we buy CDs, we only buy FDIC insured CDs. I often joke when reviewing accounts with Certificate of Deposits (CDs), that my little old CDs keep plugging along! As many of you know, CDs have been a cornerstone of our fixed income allocation for many, many years. The CDs we buy for client accounts are FDIC insured CDs from banks all over the country, but how they make their way into client accounts is very different than walking into your local bank branch and investing in one of their CDs.
I think we can all remember when bank CDs were offered in many, shall we say, creative ways! It was not just a higher rate to entice you into the local branch, but toasters, radios, clocks, and I believe I even remember a movie where a bank offered rifles! Those days are long gone. Banks now offer a boost to their rates as a way to get you in the door and get you investing in their bank. However, the CDs we invest into on behalf of our clients start life a little differently.
First, they enter the open market where they are traded. Rather than offering CDs to current bank clients, banks turn to brokerage firms and investment banks and ask them to offer a set amount of money in CDs to their clients. As an example, a bank may hire Morgan Stanley to sell $20 million in CDs. Morgan Stanley then offers the CDs to its clients, places them in brokerage accounts, and those CDs can now be traded similar to a corporate or municipal bond. If a client of the brokerage firm goes to sell the CD, it can then be bought by us and our clients. These CDs are still FDIC insured (up to the FDIC account limits), but they now have the ability to be traded. This allows us to purchase CDs at the “market interest rate”, because the CD is now competing against the same dollars as other fixed income instruments.
Secondly, with the ability to purchase also comes the ability to sell. When you invest in a CD at the bank, most investors are aware of early withdrawal penalties and limited access to funds. The CDs we purchase can be bought and sold similar to any other fixed income bond or security. If interest rates go up, the CD is worth a little less, and if interest rates go down, it is worth a little more. If you hold them to maturity, you get your investment returned plus the interest earned, FDIC insured.
Typically, since these CDs are trading on the open market, we are able to invest with very competitive rates. Meaning, we will beat the rate from your local bank. From time to time, banks do boost their rates to get money in the door, and we can’t beat those great rates!
When and Why CDs?
We often compare them to Treasury rates, muni rates, other low risk fixed income instruments, and decide which vehicle offers the best return for our clients. Most people view CDs as the lowest risk investments in their entire portfolio, considering them an extension of their bank accounts. I often use the phrase, CDs are “house” money, literally, the money you may be using to buy a house, remodel a house, pay for college, your emergency funds, etc. These are low, low risk funds. If you are less than three years away from using the money, and can’t afford to lose any principle, a CD may be the right fit for you!
Whenever explaining all of this to a new client, I always finish by saying, to end any possible confusion, when we buy CDs we only buy FDIC insured CDs.
*CDs are FDIC Insured to specific limits and offer a fixed rate of return if held to maturity.