September 21, 2017 in CDs

The pros and cons of jumbo CDs

Jumbo certificates of deposit, or CDs, aren’t going to make you rich, but they can be a good component of an overall investment and savings plan.

Gone are the days when jumbo CDs paid out a much higher interest rate than regular CDs, but they still get you a better return than hiding your money under your mattress or putting it in a savings account.

“CDs have a role to play for someone trying to save and get some type of interest rate,” says Thomas Birrittella, senior manager at EisnerAmper Wealth Advisors LLC in New York. “It’s not part of your wealth strategy; it’s more a part of your savings.”

As with any type of investment or savings vehicle, there are pros and cons to putting your money into jumbo CDs. But if you are looking for a very low-risk way to save money and you don’t need access to it for a few years, a jumbo CD may be right for you.

Jumbo CDs historically paid a higher rate than standard CDs because you were required to lock up a larger amount of money, typically a $100,000 minimum investment. Maturities are similar to traditional CDs, from one month to five years (or longer).

But the rate spread between a CD and a jumbo CD narrowed after interest rates on all deposits fell during the last recession, says Brad Jenkins, CEO of Jenkins Wealth in Centennial, Colorado. “Normally speaking, a jumbo CD should provide a higher interest rate,” Jenkins says. “It’s ‘give us $125,000, we’ll give you an extra half a percent.’ Now there’s almost no difference.”

A five-year jumbo CD with a minimum deposit of $100,000 paid on average 1.04 percent APY during the first week of September, according to Bankrate’s national survey of banks and thrifts. A traditional five-year CD paid 0.97 percent APY. Still, if you view the jumbo CD as a savings vehicle, it’s better than nothing.

Jumbo CDs also are appealing because you receive a guaranteed rate of return. It doesn’t matter if the markets tank or skyrocket. That rate is also typically higher than other “safe” investments.

High net worth investors who want to invest in jumbo CDs but don’t want to lose the Federal Deposit Insurance Corp., or FDIC, protection of up to $250,000, should spread their investment around, says Michael Brady, president of Generosity Wealth Management in Boulder, Colorado.

“What’s nice is you can put money in two different banks’ CDs very quickly and with minimal work,” Brady says. “You get double the insurance having two different banks.”

You can use a jumbo CD as collateral if you want to take a personal loan out with a bank (or secure another type of financing). Keep in mind that to use a jumbo CD as collateral, the CD can’t be part of a retirement account.

“It’s a big benefit,” says Jenkins of Jenkins Wealth. “A lot of times, you’ve got to cash out your CD.”

A jumbo CD may seem like a safe place to invest, but this savings vehicle does have its faults. One knock on jumbo CDs is that they don’t keep up with inflation.

“If you look at the inflation rate and assume 2 percent annualized inflation, you’re making less than 2 percent, and as a result, are worse off by the end of the maturity than when you started,” says Edison Byzyka, vice president of Hefty Wealth Partners in Auburn, Indiana.

“With jumbo CDs, to make (the investment) worthwhile, you’ve got to lock it up for a considerable amount of time,” Byzyka says.

The only way to protect against inflation is to invest in a longer-term jumbo CD, which can be another downside, depending on your plans for your money.

After all, penalties can be high if you cash out your jumbo CD before it matures. That’s why money managers say to invest only money that you won’t need in the next few years. If you are planning to buy a car soon, for example, you don’t want to lock in your money for five years.

“The money has to stay forgotten,” Jenkins says. “If you leave too early, you could lose the interest earned plus some of the original deposit.”

Since any investment has pros and cons, financial experts say you have to weigh everything before deciding whether a jumbo CD is right for you. You also want to make sure you are going with a bank or financial institution that has low costs associated with purchasing jumbo CDs.

Yes, you want a healthy CD yield. But if the fees are high, it may end up being a money-losing situation for you.

“Pay attention to inflation rates, and don’t get sucked in by a potentially higher yield,” Byzyka says. “That yield at the end of day likely makes you worse off than putting money under a mattress, especially in the (interest rate) environment we are heading into.”