I mentioned in a previous post Short-Term Fixed Income: CDs vs Bond Funds that I would buy CDs as short-term fixed income investment for my solo 401(k) account.
Because Fidelity administers my solo 401(k) plan, I can buy only what’s available through Fidelity. I looked at new-issue brokered CDs. The yields are lower than the best rates available from other banks and credit unions.
Then I looked at secondary CDs. Secondary CDs are like “pre-owned” cars. They are being sold by bond dealers. The dealers bought the CDs from the previous owners, who for one reason or another decided not to hold the CDs to maturity.
The good thing is that these “pre-owned” CDs still carry the same FDIC insurance. The banks are still obligated to pay the originally stated interest rate on the CDs. They don’t care whom they pay the interest to.
I guess because of the “pre-owned” image, and because the previous owners took a hit when they sold before maturity, secondary CDs have a higher yield than new issue CDs. Who wants a used one when they can buy new for the same price? A secondary CD must be priced lower than a new CD. A lower price means a higher yield.
The previous owners’ loss is my gain. I was able to pick up some good secondary CDs: 2.3% for 2-year and 2.95% for 3-year. These yields are almost as high as the best rates available elsewhere.
I paid more than the face value for some of the secondary CDs. Because the stated interest rates on those CDs are higher than the current market yield, I had to pay as much as $1,050 for each $1,000 CD. As I mentioned in the previous post, the amount I pay above the face value (“par”) is not FDIC insured. The premium CDs have a risk for the “FDIC call” if the bank fails. For these CDs, I only buy if the issuing bank is too big to fail. I bought premium CDs issued by:
- LaSalle Bank N.A. – owned by Bank of America
- Wachovia Bank FSB – owned by Wells Fargo
- World Saving Bank – owned by Wells Fargo
I don’t think FDIC will close Bank of America or Wells Fargo in the next few years.
I paid below the face value for two other CDs from banks I’ve never heard of:
- R-G Premier Bank of Puerto Rico (1-star on bankrate.com; 0-star on Bauer Financial)
- Carolina First Bank
Since the CDs are fully FDIC insured, I don’t worry about the banks. When I pay less than the face value, I’ll actually make more money if these banks fail. Let’s see how long R-G Premier of Puerto Rico lasts.
Good secondary CDs don’t show up every day. I use this bookmarklet to screen them. The bookmarklet opens three browser tabs. The first tab shows the new issue CDs. That’s the benchmark. Secondary CDs must beat new issue CDs to become worthwhile. The second tab shows secondary CDs selling below face value. I don’t have to worry about the banks for these CDs. The third tab shows secondary CDs from banks with a Moody’s rating of A3 or above and a yield of 2% or more. If I’m paying a premium, the bank had better be strong and the yield had better be good.
Good secondary CDs also don’t last long. One time I saw a good CD but I took about a minute to make up my mind. By the time I attempted to enter the order, it was gone. Someone else beat me to it.
Fidelity charges a small commission for secondary CDs: $1 per $1,000 CD and minimum $8 per order. Their quotes don’t include the commission in the yield calculation until you are in the middle of placing an order. I made a spreadsheet to calculate the after-commission yield:
The spreadsheet also calculates the weighted average yield and duration for a CD ladder. If you like managing a CD ladder, you may find the spreadsheet helpful.
Treasure hunting in secondary CDs takes a little time. So does chasing yields by opening accounts everywhere. If you think it’s too much trouble, you can just stick to a “good enough” place like PenFed or Alliant Credit Union.
Say No To Management Fees
If you are paying an advisor a percentage of your assets, you are paying 5-10x too much. Learn how to find an independent advisor, pay for advice, and only the advice.
Leave a Reply