A certificate of deposit is generally seen as a low-risk investment. Two types of CDs are available: basic and jumbo CDs. Both investments work in similar ways. But jumbo CDs require a higher deposit, they pay a higher interest rate, and they can carry more risk in certain cases. Understanding the difference between the two types of CDs will help you find a CD that meets your investment goals.
How CDs Work
When you invest in a basic or jumbo CD, you deposit money for a specific length of time. The bank may use your money to offer mortgages and other loans to its customers. To reward you for depositing your money, the bank pays you interest on your investment. When the CD matures, you receive the principal along with accrued interest. Basic and jumbos CDs are not liquid assets -- you can’t withdraw money from them before the maturity date without incurring fees and penalties.
Rate of Return
Compared to basic CDs, a jumbo CD typically provides you with a higher rate of return. For example, you might earn a 2 percent interest rate on a basic CD, but a jumbo CD might pay 5 percent. On a $250,000 investment, you'd earn $12,500 in annual interest on the jumbo CD rather than $5,000 in interest on the basic CD.
Basic and jumbo CDs are attractive because they are straightforward investments that generally provide fixed rates of return. You know exactly how much you will earn by investing your money. More financial institutions now offer CDs with variable interest rates, and these CDs generally are more complex. Another advantage of CDs is the ability to invest directly with the financial institution, avoiding broker commission fees.
The risks on a jumbo CD are typically greater than those for a standard CD. The Federal Deposit Insurance Corp. insures up to $250,000 of your money in single account. Any money invested in a jumbo CD that exceeds this amount is at risk. For example, if you bought a $250,000 jumbo CD that paid 5 percent interest in one year, the $12,500 in interest would not be insured by the FDIC, and you could close that money if the bank went under.The deposit amount on most basic CDs is less than $100,000.
- Jupiterimages/Photos.com/Getty Images