Bank certificates of deposit are getting the attention of many financial advisors as clients seek safety in tumultuous times. With three-month and six-month T-bills below 1% in early October, and taxable money-market funds below 2%, shorter-term CDs returning 3% to 4.50% have seemed an attractive alternative. 

"I'm doing more [CDs] for clients who are uncomfortable with the way the market is and [who are] riding out the storm," says Jim Watt, a fee-only advisor in Fort Collins, Colo.

This means examining clients' assets to see how much they currently have in money-market mutual funds, Watt says. "If they've got $150,000, I'll say, 'Why don't we take out $100,000 and put it in a three-month CD and $50,000 in a six-month CD?'"

Watt does not take custody of client funds. Rather than deal with a broker, he'll send clients directly to a local bank, where he believes they can often find higher yields.

Watt isn't the only advisor moving client dollars into CDs. CD trading has risen dramatically, reports BondDesk Group LLC, a Mill Valley, Calif., fixed-income electronic trading platform. According to Dave Waluk,  the group's senior managing director, CDs accounted for 43% of the total securities traded on the its platform in November-nearly double the amount of corporate bonds and municipal bonds traded. Historically, CD trading has run about 30% of the total, company officials say.

Some advisors seeking safety, liquidity and yield are staggering CD maturities to ride the yield curve. Kristine McKinley, founding principal of Beacon Financial Advisors in Lee's Summit, Mo., says she has been extending CD ladders for those clients who are already retired and have limited funds. Instead of buying staggered CD terms over a one-year period, she'll now do it over two years to make the clients feel more comfortable about meeting immediate needs.

Broker-dealers are also placing more emphasis on CDs, as more banks are issuing them, says Margie Otrove, a trader with Bergen Capital, the Hasbrouck Heights, N.J., broker-dealer division of Scott & Stringfellow Inc. "There's a lot of confidence in the FDIC and the banks," she says. "People are depending less on actual ratings."

Because of the dramatic interest in CDs and the broader risk in the banking sector, the BondDesk Group has also begun to keep tabs on the financial health of the issuing banks with data supplied by IDC Financial Publishing of Hartland, Wis. The data appear on a user's screen at the point of sale, along with a bank's FDIC certificate number. Also immediately available on the computer screen is a listing of states in which a CD can't be sold.

There are also new types of CDs in the marketplace. Otrove says brokered CDs are no longer limited to the bland fixed-rate offerings your grandmother once knew. "Basically, the world of CD products has been expanded to include more derivative type of paper with that FDIC guarantee," she says.
Most advisors are likely already aware of "callable" CDs, which often start with a high bonus rate but give the issuer the right to "call" the CD at certain intervals. Newer callable products known as "steepeners," which come with FDIC insurance and a "death put" feature, let the client participate in the return of livelier markets.

"We sell a lot of these structures," Otrove says. With equity-linked CDs, clients can take a "participation" (a percentage of the gain) in an index such as the S&P 500. Or they may have a cap on earnings. The newest steepeners, though, are linked to derivatives.

Take one offering by J.P. Morgan Chase. On October 3, this 15-year CD had an initial coupon (interest rate) of 12%. But after one year, the interest rate will be subject to change quarterly. It may also be "called" quarterly.

With this product, the rate fluctuates based on the "constant maturity swap rate," which, according to Bloomberg, is a type of interest rate swap, exchanging a LIBOR rate for a particular swap rate. As of October 3, based on the performance of this index, the coupon would have been 6.60%, Otrove reports.

The downside: It's a one-sided deal. If the CD's interest rate rises significantly, expect it to be called, forcing your client to reinvest the money at lower rates. At the same time, if the rate drops, your client, who would likely prefer to lock in a better rate elsewhere, can't withdraw the deposit for what might be up to 15 years-unless he dies.

The only option would be to sell the CD at a painfully low price on the secondary market. "That's also why you're receiving such a ridiculous coupon up front," Otrove says.

Another sweetener for CDs is the fact that, under the federal bailout bill adopted October 3, FDIC coverage against failure increased from $100,000 per owner to $250,000 per owner. Each holder of a joint account is also covered by up to $250,000, as are IRAs and certain other retirement accounts. So are trust owners and beneficiaries, as long as they follow specific rules. This means that those clients who correctly title their accounts in each of these separate account categories may be able to invest a few million dollars in CDs at one bank. Federally insured credit unions are covered by the same rules.

Caveat: The extended $250,000 coverage only applied through December 31, 2009-even to those who might have later CD maturity dates.

Clients can federally insure larger amounts of deposits by going to the Certificate of Deposit Account Registry Service (CDARS). (Local banks that participate in CDARS are listed at These banks, through the CDARS electronic system, distribute large amounts of deposits-including business and trust deposits-among separately chartered banks to ensure that all are fully FDIC-insured. All earn one interest rate.

But there are a number of considerations if you decide to invest client money in CDs-particularly through a brokerage.

In fact, John Catalfamo, a registered investment advisor and founding partner and CEO of Primoris Capital Management, Huntington, N.Y., opted for corporate bonds instead.Catalfamo considered buying CD on the secondary market. But as with bonds, he warns, the values on the screen are theoretical. You need to talk with a trader to obtain the true value.

Meanwhile, with any brokered CD, you need to analyze exactly what your client already owns and what is being bought. You don't want your client to unwittingly exceed the federal insurance limits by depositing funds at a bank where he or she already has accounts.

When a bank fails, the FDIC closes a bank and often won't pass brokered funds to an acquiring bank. Some brokers, according to FDIC spokesman David Barr, have taken as long as eight weeks to provide necessary documentation so their clients can get reimbursed.

New York financial advisor Lewis Altfest says there's another major deterrent to investing in CDs-particularly in high-tax states such as New York. "CDs have no state tax exemption, whereas [government securities] do," he says. "We're using other bond funds and U.S. government money markets rather than CDs to round out our portfolios."

There are other issues to consider as clients seek safety in bank deposits. Brokered CD terms can run as long as 20 years, they are more complex than traditional CDs and they carry more risk than "traditional CDs," warned the NASD (now FINRA) in its "Notice to Members 02-69."

The NASD/FINRA notice provides guidance about CD disclosure and sales practices. It covers loss of principal, information about the secondary market, call features and certain changes to interest rates. It advises members to provide written materials that describe the characteristics and risks of purchasing brokered CDs "sufficiently in advance of the transaction date in any brokered CD." Plus, it warns that carrying CDs at par value on account statements could be considered misleading if values are significantly eroded.

Unlike bank CDs, which often compound interest, brokered CDs generally pay simple interest. Meanwhile, if an institution is liquidated, the FDIC pays principal and interest accrued up to the date of failure. So clients who take payouts infrequently risk earning no interest on their deposit if an institution fails.
Unlike CDs at a bank, which have withdrawal penalties, CDs sold through brokers generally prohibit withdrawals-unless, typically, the owner dies. While 99% allow withdrawal upon the owner's death, Otrove notes, it's not required.

A client seeking to otherwise withdraw from a CD often must sell it on the thinly traded secondary market, risking significant losses. And deposit brokers, the NASD notice warns, are not obligated to maintain a secondary market.