What is a Jumbo CD?
A jumbo CD is a certificate of deposit (CD) which requires a higher minimum balance requirement than that required by traditional certificates of deposit. In return, the jumbo CD pays a higher interest rate. Certificates of deposit are a type of savings account that pays fixed interest in exchange for depositors leaving their funds in the account until a specified maturity date.
Explanation of Jumbo CDs
Traditional certificates of deposit generally offer a higher rate of return (RoR) than standard savings accounts or interest-bearing chequing accounts. In the same vein, the jumbo CD will pay an even higher rate than traditional CDs. Jumbos benefit from a higher price because they require a higher minimum investment than the standard CD. Most giant CDs start at $ 100,000, but the financial institution offering the product may have certain products that have lower entry points.
Jumbo CDs are considered risk-free investments because they are insured up to $ 250,000 by the Federal Deposit Insurance Corporation (FDIC). Credit unions also market giant CDs, and these funds are protected by the National Credit Union Administration (NCUA).
Key points to remember
- A jumbo CD is a certificate of deposit (CD) with a minimum balance of $ 100,000.
- Although Jumbo CDs have higher minimum balance requirements than traditional CDs, in return they pay a higher interest rate than conventional CDs.
- Jumbo CDs pay investors a fixed interest rate, which helps stabilize the returns on an investment portfolio by partially offsetting market risk.
- Jumbo CDs can be used as collateral for loans.
Revenues of Jumbo CDs
Investors receive the premium – based on the fixed interest rate – as compensation for not having access to their money during the life of the account. For example, a giant one-year CD that pays 1.5% interest may require the funds to remain frozen in the account for one year. Jumbo CDs can have durations as short as a few days or as long as ten years. However, the standard range is between three months and five years. In addition, the longer the term, the higher the interest rate on the funds invested.
When the CD matures, the financial institution returns the capital of the investor. Early withdrawals may be possible, depending on the conditions of the product purchased. However, the investor will pay a penalty for early termination of the contract.
How Investors Use Jumbo CDs
Large institutional investors are the typical client for giant CDs. These large institutions include banks, certain large corporations, and pension funds. This is mainly due to the high minimum balance requirements. These clients use giant CDs as a temporary investment vehicle, as some issuers have tenors for as little as seven days. Short-term maturities allow institutional investors and companies to earn interest on money unused for short periods of time before transferring funds to other companies.
In addition to being paid to park their funds in these products, large investors use them as instruments to reduce the market risk exposure of their portfolio. Market risk arises when stock prices fluctuate over time. As a result, equity portfolios can generate high returns, but they can also experience significant losses. The constant interest paid on giant CDs makes it possible to compensate for and reduce the risk of negative returns that may arise from holding shares.
A company seeking a loan or other type of financing from a bank can pledge its jumbo CD as collateral. Collateral is an asset held by a lender as collateral for a loan in the event that the borrower is late or defaults. If the borrower fails to present his payments in a timely manner, the lender can seize the collateral to recover the losses. However, certificates of deposit held in retirement accounts cannot be used as collateral for loans.
Risks and disadvantages of Jumbo CDs
Although jumbo CDs have the positive aspects of higher rates and FDIC protection, there are drawbacks to investing in them. Historically, jumbo CDs have paid a much higher rate than traditional CDs and savings accounts. However, the differences between these yields have narrowed in recent years, making a giant CD a less restrictive investment.
Jumbo CDs generally do not track inflation, known as inflationary risk. Inflation is a measure of the pace of price increases in the economy. For example, if the inflation rate in the economy is 2% and the interest rate on the CD is 2.5%, the investor earns only 0.5% in real terms. For an investment in a giant CD to be worthwhile, investors would have to lock in their funds for the longer term, which would result in a higher rate.
Early withdrawal penalties
If the holder needed these funds before the maturity of the Jumbo CD, withdrawal would result in a penalty. The penalty may be a commission imposed by the bank, or the investor could lose the interest earned to date. Each bank will have specific rules and guidelines for early withdrawals. If it is likely that the funds will be needed before the CD matures, investors could better invest the funds in an account that has no withdrawal restrictions such as a high interest savings account.
Interest rate risk
Another concern for giant CD investors is the interest rate risk. This risk arises when current market interest rates exceed those offered by the giant CD. If interest rates rise while investors hold a Jumbo CD, they will not enjoy the higher rates if these funds were free to invest elsewhere.
Conversely, if interest rates fall during the holding period, at maturity, the investor may not be able to reinvest the funds at a rate comparable to that of the CD. This danger is called reinvestment risk. Although jumbo CDs pay a higher rate at the start compared to other products, investors need to weigh the pros and cons to make sure they don’t end up with lower returns in the long run.
Jumbo CDs offer a constant interest rate for the duration of the holding.
Jumbo CDs generally pay a higher interest rate than traditional CDs or savings accounts.
The regular interest paid on Jumbo CDs may partially offset the market risk of the portfolio linked to the negative returns on the shares held.
Jumbo CDs are guaranteed up to $ 250,000 per account by the FDIC or the NCUA.
Jumbo CDs offer a lower return than many other fixed rate investments such as bonds.
In an environment of rising interest rates, giant CDs face an interest rate risk, because investors can hold a CD paying a lower rate.
Jumbo CDs generally do not keep up with inflation, which means that prices could rise faster than the CD’s rate of return.
Investors cannot access their funds on CD Jumbo before maturity without incurring an early withdrawal penalty.
Jumbo CDs may have high minimum balance requirements.
Real example of a Jumbo CD
Wells Fargo Bank (WFC) is a consumer bank in the United States that offers many types of CDs, including jumbo CDs. Here are examples of the jumbo rate as of April 13, 2019:
- A six month jumbo CD with a minimum deposit of $ 100,000 earns 1.15%.
- A one year jumbo CD with a minimum deposit of $ 100,000 pays 1.25%.
Please note that the interest rates offered by the bank may change at any time for new CDs and may be different depending on the state of the depositor.