A jumbo certificate of deposit (CD) works like a regular CD, except that it requires a significantly larger investment and, in return, pays a higher rate of interest. Some financial institutions require an investment of at least $100,000, while others set lower minimums. Jumbo CDs can be useful in certain circumstances, but they also come with risks. Here's what you need to know.
- Jumbo CDs work like regular CDs, but require a larger minimum deposit and pay a higher interest rate.
- Jumbo CDs are also available in a wider range of terms, from very short to very long.
- Some issuers call any CD of $100,000 or more "jumbo," while others have different limits or use different terminology.
- The main customers for jumbo CDs are large companies or institutional investors looking for a safe place to park money that would otherwise not be earning any return.
Understanding Jumbo CDs
Jumbo CDs are mainly used by institutional investors and businesses, rather than individuals.
As with other CDs, the investor agrees to leave their money in the jumbo CD for a designated period of time. In return, the issuer will pay an interest rate that's typically higher than other types of savings accounts. The downside is that the investor's money isn't liquid. If they want it out before the CD's term ends, they'll typically have to pay a hefty early-withdrawal penalty.
Unlike regular CDs, which are often available for an investment of $500, $1,000, or have no minimum at all, most jumbo CDs start at $100,000, although some financial institutions offer a few products with lower entry points. In exchange for depositing more money into the CD, the customer receives a higher interest rate than they would with a regular CD.
Another difference is that the term length for jumbo CDs can be much shorter or longer than a regular CD. Terms for regular CDs commonly range between three months and five years; jumbo CDs can have terms as short as a few days or as long as a decade or more.
In other ways, regular CDs and jumbo CDs are very similar. Crucially, that includes the federal insurance offered on the balances held in these accounts. Jumbo CDs, just like regular CDs, are insured for up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA), for banks and credit unions respectively.
Advantages of Jumbo CDs
The main customers for jumbo CDs are corporations and institutional investors. A CD (whether jumbo or not) is generally regarded as a good place to store money for a short period before it is needed elsewhere. While the average individual might not have hundreds of thousands of dollars of cash that they don't need right now, large institutional investors sometimes do.
Putting those funds into a jumbo CD can be a way for these investors to achieve a number of objectives:
- It allows the investors to earn a little interest on money that would otherwise be idle. Funds can be parked in a jumbo CD for as little as a few days. And while the interest rate might be low on such a CD, it's better than nothing.
- Large investors also use jumbo CDs as instruments to reduce their portfolio's market risk exposure. The steady interest paid on jumbo CDs helps offset the risk of negative returns from other holdings, such as stocks or bonds.
- Businesses seeking a loan or other type of financing from a bank can pledge a jumbo CD as collateral.
For all those reasons, jumbo CDs can be invaluable to businesses and large investors trying to make the most of their funds. However, they are unlikely to be of much use to the average individual investor. If you are looking to save $100,000 for retirement, for example, there are more effective ways to do so than with a CD.
Disadvantages of Jumbo CDs
While jumbo CDs have their uses, they also have some risks. Historically, jumbo CDs have paid a much higher rate than traditional CDs and savings accounts. However, in recent years the gap has narrowed and neither type now pays a particularly high return.
In addition, jumbo CDs face some other dangers:
- Inflation risk: Jumbo CDs may barely keep up with inflation. If the inflation rate in the overall economy is 2%, for example, and the interest rate on the CD is 2.5%, the investor is only earning 0.5% in real terms. To make an investment in a jumbo CD worthwhile, investors would need to lock in their funds for longer terms, resulting in a higher rate. But that would subject them to even greater inflation risk.
- Interest rate risk: When the interest rates offered on new CDs exceed those on existing ones, a jumbo CD can lose value. This interest rate risk is not an issue with a CD that's held to maturity, but it can affect the value of a CD if the owner wishes to sell it on the secondary market, which is an option with brokered CDs.
- Opportunity cost: Investors who are locked into a jumbo CD can miss out on higher rates or other investment opportunities they could have taken advantage of if their money was more liquid. Because so much money is involved with a jumbo CD, the cost could be substantial.
- Early-withdrawal penalties: As with a regular CD, early withdrawals from jumbo CDs can incur penalties. If it's likely that the funds might be needed before the CD's maturity, the investor could be better off investing in a more liquid account, such as a high-yield savings account.
All of these risks aside, however, jumbo CDs remain useful tools in the right situation.
What Is a Brokered CD?
Brokered CDs, which can be jumbo size, are sold by brokerage firms and independent sales representatives. They typically pay higher interest rates than CDs from banks and credit unions but may not provide the same federal insurance protection.
What Is a Callable CD?
Callable CDs contain a provision that allows the issuer to call (or redeem) the CD at its discretion. The issuer might do that if interest rates are falling and you're holding a CD with a high interest rate. You'll get your principal back, plus any interest you've earned to that point, but you'll now have to reinvest your money, most likely at a lower interest rate.
What Is a Negotiable Certificate of Deposit?
A negotiable CD is one that you can sell to someone else if you don't wish to hold it to maturity or pay a penalty for taking money out early. Jumbo CDs are usually negotiable. In fact, jumbos are sometimes referred to simply as "negotiable CDs." Conventional CDs, on the other hand, typically aren't negotiable; when you buy one, it's issued in your name, and you're the only one who can collect on it at maturity.
The Bottom Line
Jumbo CDs are much like regular CDs, except that they require a larger deposit, pay higher rates of interest, and can come in shorter and longer term lengths. In addition, some jumbo CDs can be traded on the secondary market. Many jumbo issuers require a minimum investment of $100,000, but others set lower or higher minimums. Jumbo CDs are of the greatest use to large companies or institutional investors that looking for a safe place to park some spare cash for a set time period.