I dipped my toe into peer to peer lending beginning in October. I’ve only invested $1000 in a taxable account at Lending Club, mostly as an experiment. If I get serious about it, I’ll eventually roll over part of a Roth IRA there, perhaps even 5% of my portfolio. Since the earnings are completely taxable, it isn’t a very tax efficient investment and really doesn’t belong in a taxable account. But so far things have been pretty promising.
My $1000 allowed me to invest in 40 different loans at $25 a piece. I’ve been through one complete payment cycle, and so far, all 40 of them have made their payments. My goal with this batch was not necessarily to get the highest possible return, but rather to minimize my defaults. My average interest rate on these loans is 9.18%. So far I’ve had 27.90 paid back in principal and $10.54 in interest. Lending Club calculates out my return as an annualized 9.18%. My calculation is a little different.
Calculating My Return
I began deploying the money into loans on 10/27. It took me a full 3 weeks to finally get all the money into loans and get the loans funded. I used a credit card to fund the account (one big advantage Lending Club has over Prosper), so the money didn’t actually leave my banking account until I paid that bill on 11/18. I also got an extra $20 on that date from my credit card, so I’ll count that in as part of my return. That comes out to a 33.2% annualized return. Not too shabby. Without the extra $20, I still get a 10.3% annualized return with XIRR. That’ll come down as time goes on, of course, even without the inevitable defaults.
As the payments come in I’m reinvesting them into much riskier loans, as discussed in this post, hoping for a higher return despite a higher default rate. For instance, I used the payments this month to reinvest into a loan at 23.91%.
A Few Observations
The more I learn about this asset class the more excited I get about it. In this era of very low interest rates, anything better than 1-2% seems pretty good! I expect long-term returns from this investment to be somewhere between 4% and 10%, which really isn’t all that different from the stock market. This seems like an appropriate range given past returns available on lendstats.com
|Peer to Peer Lending Returns|
|Year of Loan Origination||Prosper Average Return||Lending Club Average Return|
Two things are important to get these returns-diversification to prevent doing worse than 4%, and proper bond selection to do better than the average loan on the platforms, which as you can see, range from 4.6% to 9.5% (but are likely to continue downward as defaults occur.) As an added benefit to a portfolio, the correlations theoretically ought to be quite low between peer to peer lending and both bonds and stocks. I’ve run into two problems though.
The first issue is that the most profitable loans are some of the hardest to find. People aren’t interested in the 60 month E-G (riskiest) loans, so many of them never really get funded. My recent loan was for $25,000 and it ended up only partially funding for only $18,000. In cases like this, the borrower gets the option to take the partial funding or re-list the loan. Mine apparently elected to take what he could get. But when I was looking for a loan that met my criteria, it appeared that only 1 out of 10 of the high risk loans was going to fund, even partially. Perhaps that’s just because I was looking over Christmas weekend, since supposedly over half of the loans on the platform fund, but it can really limit your options.
The second issue is that this can be immensely time consuming. When I go to invest $20K at Vanguard it takes 5 or 10 clicks and I’ve got $20K into a mutual fund. Deploying $20K at Lending Club could take a year if you were particularly picky and only putting in $25 per loan. You can automate some things, and you can even have Lending Club deploy the money for you. But then you’ll have to settle for something closer to the average returns. If you’re hoping to juice those by 2% or more, then you’ll have to spend a little more time selecting your loans. Alternatively, you can put in more per loan, but that may sacrifice some of the diversification you could have.
It’s tough to balance your time against either a lower return, or less diversification. For this reason, peer to peer lending may not be the best investment for a busy doctor looking to deploy a significant chunk of his portfolio. But with a volatile equity market, and historically low returns on fixed income, it might be worth it, especially for someone who likes to tinker with investments. Unlike picking stocks, the peer to peer lending market doesn’t appear to be very efficient, and active management may still yield some alpha to the diligent investor.
Addendum: Lending club has a special deal going right now. If you invest in larger loans (>$20K), you get the lending club management fee (1%) waived. That adds 1% to your return. According to Lendstats.com, larger loans have had a higher return over the last two years. (8.4% vs 6.2%) If you’ve been delaying signing up waiting for a special offer, this might be the additional push you need. Not sure how long this will last.