Jumbo CD rates are still relatively low, but if you're planning to put $100,000 or more in a short-term savings or fixed-income investment vehicle, then a jumbo CD may be right for you. Let's take a closer look at fixed-income investments such as CDs, as well as bonds and bond funds, and savings accounts.
What is a jumbo CD?In the simplest terms, a jumbo CD is a certificate of deposit with a minimum $100,000 deposit. Historically, jumbo CDs have paid a higher interest yield than CDs with a lower deposit minimum, but the current low-interest rate environment just isn't supporting that. A quick Googlesearch turned up similar rates for three- and five-year CDs -- both jumbo ones and those with a lower minimum deposit.
Continue Reading Below
CDs, bonds, and savings accounts historically don't provide the best long-term returns. That's not to say they're inferior -- it's just that they're different. It's kind of like comparing a tank and a car.
Data above from various sources including U.S. Census Bureau, Bankrate.com, YCharts.com. S&P 500 data is historical average annualized rate of return. All others are available rate of return at beginning of each year, and may have varied at different points throughout each year. Rates are not adjusted for inflation, and reflect real rates of return at the time.
As you can see in the table above, the historical rates of return for theS&P 500-- a solid proxy for measuring stock market returns -- has been consistently the best way to grow your money. But it comes with the risk of short-term losses, as we saw in the 2008 -2009 recession.
If you're concerned about short-term risk and threats to your cash -- such as saving for a down payment on a house, or retirement income you'll need in the next few years -- then a CD is a "tank" that will keep your capital safer against outside threats than a car would. It's just not going to go anywhere very quickly.
But if you're saving for retirement and you're 45, a car would make the better choice for that "cross-country trip." Not only would you reach your destination much more quickly in a car than a tank in the vast majority of circumstances, but you'd also do it even if you had 10 flat tires (bad market years) and a blown transmission (major recession) on the way. Cars perform better than tanks in most circumstances when we have time on our side, while tanks are pretty awesome when safety is the goal.
Just as you'd never make a tank your daily driver -- despite how awesome that would be for about a week -- it's not a good investment practice to used CDs, bonds, or savings accounts as your "daily driver" for long-term investing gains. Tanks may be safe, but if you sacrifice too much performance for safety, here's the result:
What the table shows is just how much better -- over the long term -- stock market returns have been, as compared with even double the current available interest rates in CDs. That's not to say you can guarantee these kinds of returns, since the past 35 years have been pretty good, even with several major recessions and the accompanying market pullbacks.
But there's little doubt that in the long run, stocks will continue to outperform CD and bond rates.
It gets back to your objectives and time frameIf we go back to our "car versus tank" comparison, investing in a CD or bond shouldn't be about outsized returns, but to protect against capital losses first, and then gain some return second. For example, if you're closing in on retirement, it's reasonable that you would shift retirement savings that will be your income in the next several years into CDs, bonds, or other fixed-income investments that reduce the risk of capital losses. You may not get 25% returns in a great year, but you won't lose 25% that you can't live without in a bad one.
If that's your situation, then a CD -- whether it's a jumbo or not -- could be a fine place to park your money for three or five years. In the current interest rate environment, short-term bonds (notbond mutual funds or ETFs) can also be solid alternatives, as long as the redemption date is before you'll need the money.
Putting it all togetherBefore investing in anything, make sure that you're 100% clear on your objectives and time frame, and invest it accordingly. In the current interest rate environment, many fixed-income investments could lose redemption value, so make sure you choose an investment that comes duebefore you'll need the money. That's the only way you can make sure you'll get face value at redemption. Bonds are especially at risk in the current environment, since they would lose value on the secondary market (where you would sell them before redemption) when rates go up.
If your timeframe is less certain but still short-term, many CDs have relatively easy early redemption terms that don't cost a lot in fees. Make sure you understand the policy, and compare both regular and jumbo CDs to get the best rate.
Lastly, if it's a long-term investment, stocks are historically the best choice. Don't mistake the short-term safety of CDs and bonds for being superior to stocks -- or the other way around. Just choose the best vehicle for the trip you're taking.
The article Jumbo CD Rates: Is a Jumbo CD Right for You? originally appeared on Fool.com.
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.