Those of you who have been following the blog for years know that I make changes to my portfolio quite infrequently. However, one change I have made was to add a risky fixed-income asset class called Peer to Peer Loans two years ago. I added it to provide diversification and to boost returns (especially given the very low fixed income returns available in our current low interest rate environment.) I figure if you're going to chase yield, you might as well go big. That said, this is an asset class with serious downsides. You're loaning money to people based on a promise and a signature, no collateral. Your only recourse if they default is to ruin their credit score. You also are quite dependent on one firm (or a couple of firms) to not go out of business. If Lending Club or Prosper fails, it's going to be ugly. Also, this asset class is somewhat illiquid due to a secondary market with serious issues, although by using the Sacramento method you can at least get out of good loans relatively easily. Perhaps most importantly, investing in this asset class can be very time-consuming, although there are ways to reduce that hassle factor.
I haven't written about my investment in Peer to Peer Loans for about a year, but it's still going just as well as ever. One development that has really affected me is that Lending Club stopped allowing you to sell loans where payments were late or pending. That changed my strategy a bit. Up until that point, I hadn't had a default yet (since I sold loans off for 20-80% of their value while they were late but before they defaulted.) So now I have a lot more late loans and a few defaults. That's okay, it doesn't seem to affect my returns much. Some of them go back to paying off their loans and some don't, but since I was selling the late ones at such a big discount, it's about the same result in the end. I did finally get my investment up to 5% of my portfolio, primarily in a Roth IRA at Lending Club.
Disclosure
The reader should also be aware that if you open an account with Prosper or Lending Club through links on this page, I get a small commission. Truthfully, I don't think I've gotten more than a handful of these in a couple of years, so this is essentially insignificant income to this website. But it is a conflict of interest and I'm big on disclosing them.
Now, let's talk about how I've done.
My Experimental Lending Club Account
My oldest account is a $1000 Lending Club taxable account I opened in November 2011. I haven't added any money to it at all. My initial investments were on the conservative end of the scale, but after a year or so I began investing it just like my Lending Club Roth IRA- aggressively in the riskier loans that generally had higher returns. Here's what the account looks like:
You can see a few things from this account. First, since you can't invest less than $25, this account has always had some significant cash drag since Lending Club pays 0% on cash. Second, although there were originally just 40 notes, I have had a total of 93 (and I don't believe that counts the few that I sold while they were late.) The average note size is obviously now less than $25 each. I have had one of these “charged off.” I bought it in March 2013, they made 11 payments, and then that was it. So I didn't lose the whole investment, but I did lose over 80% of my principal on it. The 2 late notes also made payments for about a year before they stopped paying. Meanwhile, 21 people have paid off their loans completely, many far ahead of time, for better or worse. You'll also notice that I have an “adjusted account value.” This is a relatively new development from Lending Club that lets me reduce the value of late loans. I have it set so grace period loans are discounted 20%, 15-30 day late loans are discounted 50%, loans > 31 days late are discounted 95%, and charged off loans are discounted 100%. It's a more accurate way to look at the account value in my opinion.
My overall XIRRed return for this account is an annualized 10.4%. Not too bad, and worth the risk IMHO.
My Experimental Prosper Account
Shortly after opening the Lending Club account, I opened a $500 Taxable Account at Prosper. If you thought there was a lot of cash drag on a $1000 account, you should see a $500 account. I actually had negative returns on this account for quite a while (due to the drag and a few early defaults), but it's gotten better since. Here's what it looks like currently.
Prosper never let me sell late loans, so I never really sold any. At any rate, as you can see, I concentrate on the mid-range notes at Prosper, in the B, C, and D ranges (and especially like people with previous Prosper loans). I've gotten pretty lucky in the few risky (E and HR) loans I've bought. Although I started with 15 loans, I've had a total of 42. 25 loans are current, 3 are late, 9 have been paid in full, and 5 have defaulted. I received anywhere from $1.89 to $8.27 from these $25 notes prior to their default. My XIRRed returns have been:
- 2012 (11 months): 4.48%
- 2013: 10.64%
- 2014 (5 months): 3.49%
- Overall: 8.05%
The Main Account
Since P2P Loans are very tax-inefficient, it's best to invest in them in a tax-protected account. I've gradually rolled Roth IRA money over to Lending Club and invested it in P2P loans, beginning in September 2012 and most recently in April 2014. I would roll over a few thousand, give it time to get invested, and then roll over a few thousand more. It took me essentially a year and a half to get 5% of my portfolio invested. I could have done it faster, but I couldn't have been as picky with which loans I invested in. Here is what this account looks like:
These were initially $25 loans, but I went to $50 loans when loans became more scarce a year ago so it didn't take quite so long to get my money invested. This account has always been invested aggressively. Lending Club claims I'm making 20% on this account. That's not true, it's actually 13.00%. It's interesting that despite this account only being a year and a half old, and that I generally invest in 5 year loans, 10% of the loans I've ever made have been paid in full. Apparently there are a few intelligent people out there that realize carrying a 20% loan for 5 years is pretty stupid. For the rest of them, I'll continue to take their money. It's hard to tell exactly how many of the loans that I have bought have defaulted, since for the first year I sold all the late ones. But in the last 6 months since they've made it more difficult to sell loans that are about to default (and since I've lost interest in spending time trying to sell these), I've got about a dozen that look like they're going to default.
Overall Returns
So to summarize my returns:
- Annualized Prosper Return (on a tiny account): 8.05%
- Annualized Lending Club Return (on a tiny account): 10.45%
- Annualized Lending Club Return (on a larger account that has always been invested aggressively:13.00%
- Annualized Lending Club Return (on both accounts): 12.81%
- Overall 2011 Return (6 weeks): 3.22%
- Overall 2012 Return: 12.65%
- Overall 2013 Return: 13.16%
- Overall 2014 Return (5 months): 4.76%
- Annualized Overall P2PL Return: 12.60%
I feel pretty good about these, given that the average returns for Prosper and Lending Club tend to be in the 6-7% range. My active management appears to be adding some value.
Want to Play?
If you'd like to get in on Peer to Peer Investing, I would appreciate it if you would use the links on this page to open your accounts.
Please be sure to limit your investment in this risky asset class. It might be fixed income, but these aren't treasuries and there are some very unique risks in play here. In many ways, the risk is greater than buying equity index funds. I suggest starting with a tiny experimental account before rolling over any serious IRA money to invest. Also look into a way to automate your investing. Without that, it can be a major time hassle. But as you can see, potentially good returns are available and the faster your money grows, the sooner you reach your goals.
What do you think? Do you invest in P2P Loans? Why or why not? Have you been pleased or disappointed with your returns? Comment below!
It’s early going for me at this point. I invested about half of my $10K IRA account in high grade, half in riskier – as money becomes available, I am putting it all into riskier, higher interest rate loans at this point. Lending Club calculates my returns at 9.42% so far, although I understand not everyone likes the way they make the calculations and the portfolio is not old enough for many of the collections issues to arise. One comment I have is that, on my first loan to go bad, I only have $25 in it, so not a big deal, but wanted to understand the process, so kept checking the collection notes, which were initially and for a long time just this:
5/5/14 (Monday) Collections Agency attempted to contact borrower
4/30/14 (Wednesday) Engaged external collections agency
Eventually, a few weeks ago, I inquired as to why the log was not being updated or why collections efforts had ceased – either one was contrary to what I was promised by LC as an investor. Oddly, this seemed to initiate (or odd coincidence) a flurry of activity, resulting in perhaps some forward progress with the delinquent borrower:
6/24/14 (Tuesday) Borrower contacted Lending Club
6/23/14 (Monday) Sent email to borrower
6/23/14 (Monday) Sent email to borrower
6/23/14 (Monday) Borrower located using alternative means (skip trace)
6/23/14 (Monday) Borrower located using alternative means (skip trace)
6/23/14 (Monday) Borrower located using alternative means (skip trace)
6/23/14 (Monday) Attempted to contact borrower (left voicemail)
When I replied to my original inquiry email saying there must be some mistake because there’s no way all that activity could have happened in one day, the response I received was, yes, the log is correct, all this took place in one day.
So, keeping in mind my largest concern here isn’t the $25, and I understand some loans go bad, etc., but seemed to me based on this experience that the collections efforts were sporadic, not well organized, and possilbly only pursued diligently following my inquiry. So I am left wondering, is LC really delivering on their twin promises of trying to collect from delinquent borroers and updating investors about these collections efforts?
If, as LC tells me, the above log is correct, then it seems, at least in this instance, the answer is no. The delinquent borrower should not be left alone for 7 weeks after collections efforts have already been initiated. Anyone able to shed any light on this that LC’s customer service wasn’t able to?
WCI,
We are currently in a bull market. More and more people are borrowing money and since the market is good, are paying off their debt. How do you feel this will change during a recession? I feel like there is a lot more unstated risk in these investments. If you have equities and a recession comes along, you can loose half your value, but generally over some time you will recoupe those losses. With P2P, once they default you probably will never see that money again. These loans are obviously high risk to begin with as they were unable to procure money at a lower rate from a traditional bank. Therefor they are at a very high risk of default in a down market invironment. What are your thought? Is the extra 4% on returns today worth the risk of a huge recession related default tomorrow?
The people who are borrowing money from Lending Club and Prosper don’t have much money in the market. If you’re dumb enough to take out a loan at 20% are you really smart enough to fund a Roth IRA? I doubt it. I don’t think market returns will have much effect. Now unemployment on the other hand, that’s a concern.
I’m not sure where you’re getting “4% extra” from. Treasuries are paying 2%. I’m earning 12%+. That’s 10% extra. Yes, I do think that’s worth the risk, otherwise I wouldn’t be doing it. But even a fan of P2PL like me is limiting this to just 1/20th of my portfolio.
Really?? If the banks won’t loan them money, why would I?
If I feel the urge to gamble, I get on a plane to Las Vegas and have fun for the weekend.
I don’t gamble with my retirement money.
Banks loaned most of these people money just fine. They did it at 25-30% with lots of fees. That’s why they’re willing to consolidate/refinance that debt with you for 20-22%. Calculate what percentage of them have to default for you to lose money at those rates. Then decide if you think that’s likely given the historical data.
Thank you for the update Jim!
I love Prosper and pleased that I diversified into notes. Just another piece of the pie.
******
I’m $32k invested. Over 1,200 notes in 18 months. Currently at 12.61% in a taxable account. I log on 2x per day and 2x on the weekends when possible. It was irritating logging-in for the first 8 months (@ 330 times), now I get excited because I see my reinvested dividends growing.
“I suggest starting with a tiny experimental account before rolling over any serious IRA money to invest.” … Great advice! That’s exactly what I did!
I cringe reading this … “Since P2P Loans are very tax-inefficient, it’s best to invest in them in a tax-protected account.”
Now that I’m 18 months in and comfortable with the process I have a question.
Q: Can I transfer some of the 32k from the taxable account into my Vanguard ROTH account and move the ROTH money (in cash) out (I’m already maxxed out for the year) or would I have to open a new account and start from scratch?
I haven’t called Prosper or Vanguard yet. This is a timely and coincidental article.
Thanks again!
You usually cannot transfer securities in-kind into an IRA. You’ll have to liquidate them and start over. Bummer huh. Hope you’re in a low tax bracket so it doesn’t matter as much. The good news is that you can claim defaulted notes as losses on your taxes, which you can’t do in an IRA.
I’d just do future contributions in an IRA/Roth IRA and let your taxable ride. You can gradually withdraw that money as it pays out (far less hassle than withdrawing from an IRA BTW) if you like.
P.S. If I were logging in 2 times per day I’d have quit a long time ago. I might be logging in 2 times per month now, but I’m thinking about stopping even that as it’s hard to sell late loans for a reasonable price (the reason I was logging in at all.)
Did you just compare P2P Lending to treasuries? That’s worse than comparing bonds to high dividend stocks. If you want to compare it to bonds, then the junkiest of junk bonds maybe would be closer. I chose to compare it to equities which is still incorrect as it is more risky than equities. With equities in a down market I may loose 50% of its value, but eventually prices will return. If someone defaults, you are out of luck and your money is gone. I think that is the real risk of this investment strategy.
Don’t get me wrong. I am thrilled you averaged 12.6% in 2 years. But lets compare that to TSM (total stock market) that averaged 16% in the last 3 years and 9.6% since 1992. Is the risk you are taking really worth it? I assume you are taking 5% of your equities allocation towards P2P. If you are using your bond allocation, then I think we have other things to discuss.
Now, please correct me if I am wrong, but what do you think will happen when the people you loan to start losing their job? What is your real downside on this investment when our next recession hits? Maybe I just don’t get it, but for “me” the couple of percent I get above equities is not worth the risk.
While that’s a reasonable question (whether P2P Loans are riskier than TSM) it’s obvious that P2PL are far riskier than treasuries. That’s why the return is so much higher. Is the risk adjusted return better? I think so, you obviously don’t, and that’s fine. P2PL is a totally optional asset class.
But let’s think about this for a minute. Consider a portfolio of 3 year notes yielding 20%. How many of them need to default for me to break even? If 20% of them NEVER paid a single payment and no money was recovered from them, but I got 20% returns per year for the other 80%, that comes out to an overall return of 11.4% per year. What if 40% of them defaulted on the first day they got the loan? I’d end up with an annualized return of 1.2%.
So I really can tolerate a default rate of over 40% and still break even. What has the default rate been? According to this analysis: http://www.lendingmemo.com/lending-club-prosper-default-rates/ somewhere between 3% and 8% per year, or for a three year note, perhaps 9%-24%. For me to start losing money that’s going to have to get A LOT worse.
Why do you think banks sent out credit cards to all these folks in the first place? Because even with the high default rates they’re still making a good return on their money.
And I’m not sure why you’re so concerned about whether I’m pulling P2PL out of the equity or fixed side. Do you really think an 80/20 portfolio performs that much differently from a 75/25 portfolio?
You make so much sense, WCI.
Truly enlightening.
I started investing with Prosper in 2005. Most of my loans were high quality A and B rated. Everything was fine until the economy started to get bad. Then a large number of my loans started to default. I would never have predicted how many highly rated loans would default. I am not sure what the issue was (borrower fraud, lack of oversight by Prosper, lack of followup on delinquencies, etc) but by the end of 2008 I had lost money on my investment overall. I am taking a fresh look at the P2P market to see how the industry has changed, but I am still very wary as to how the loans would fare in a worsening economy. fortunately I did not have a large amount invested but it makes me a little nervous to see people investing even 5% of their retirement in this risky asset class.
There is a lot of discussion in the P2P community about the difference between Prosper 1.0 and Prosper 2.0. While no one can be sure it wasn’t all due to a souring economy, it seems the changes made by Prosper (primarily having higher standards for who can get a loan) have at least somewhat fixed the problem.
I had a similar experience. I got involved with Prosper when it was brand new as well. After a large number of defaults, I ended with a return of about exactly 0%. It has probably been much improved and fine tuned now, but can’t get myself to go back to it.
Opened an account with lending club about a year ago but still have yet to fund it because of my wife’s concerns with the whole concept of peer to peer lending. I was under the impression that some larger entities had discovered the profitability in many of these loans and were scooping the more desirable ones up immediately as they became available thus making investing in the choice noted very difficult. Are you still encountereing this issue WCI? Have you loosened your standards or are you just more patient when it comes to getting the money in play?
I finally got all the money I’m interested in putting in “into play.” I’ll have to deploy a few thousand more each year to stay at 5% of my portfolio, but that’s not hard, just a partial Roth rollover that takes me about 10 minutes to do the paperwork. It’s all on autopilot for me.
If your wife is uncomfortable with the asset class, I’d skip it. It’s certainly optional. You guys need to be on the same page with your investments.
We are having the same husband/wife disagreement on P2P lending. Good to know that there is another woman that thinks like mine. 🙂
Thanks for the link. I will read it when I get home. I really want to analyze that data about default rates.
As for where you pull your 5% from means nothing to me, but it should to you. The question that needs to be asked is how much in fixes income do you need to sleep well at night while at the same time have necessary fodder for rebalancing in a downturn. Benjamin Graham recommends no less than 25% in bonds.
My point being if you are pulling money from your bond/fixed income portion, you are then assuming it is as safe as a bonds or CDs which I think is a big mistake.
Like you said, you wanna take 5% of your assets and gamble a little then that’s fine. I will reply again later after reading the link above regarding defaults.
Do you know of any P2P options for those of us living in the majority of states where Lending Tree and Prosper are not approved? Any options for accredited investors? Thanks.
It’s Lending Club, not Lending Tree (which I think does mortgage loans.) Funny how often I see that error.
You can buy P2P loans on the after-market in many states. There are also other P2P companies out there but I don’t know nearly as much about them. I also am not aware of any that just work with accredited investors, although I believe there are some funds out there available to accredited investors that may get you around the residency issue. A great resource for both those questions is Peter Renton at Lend Academy.
WCI,
I finally got a chance to take a look at the link regarding defaults. It is definitely interesting regarding how the default process actually works and how getting a few payments early on decreases the loss from the default. There is a very interesting comment to that blog post regarding how you need to keep buying new loans since new loans are less likely to default compared to older loans which ends up keeping your returns high. Another issue I have is that there is no data prior to our last recession. The data starts from January 2009 and it is towards the end of the recession before markets started going up in March. I wonder what the default rate would be for loans bought before 2008. Since the best way to keep your returns high, you must keep re-investing your cash into new loans therefor 100% of your money is at risk for a loss in a big unemployment surge which could occur in a recession. Worst case scenario would be a recession hits, borrowers get laid off and default. The ones that don’t send you their payments which you re-invest, but since the default rate is increasing as more people get laid off, they default also leading to a perpetual cycle of decreasing returns and eventual loss in your original investment. Maybe my thinking is off and it would require some serious computation to prove or disprove my theory. Either way I see a decent amount of risk is taken here.
During a recession you want reserves to be able to cash in and invest in stocks while they are cheap. Unfortunately your P2P loans will also go down decreasing your ability to buy cheap equities. Which goes back to my previous question if you consider these as part of your bonds or as part of your equities asset allocation.
If this was such a great investment, why is Lending Tree and Prosper acting as middle men instead of being direct investors?
Investing 5% into any asset class isn’t going to make or break your portfolio but I have another question to ask you. You have a great career and have amassed quite a good nest egg. You even made a post regarding “The Concept of Being Done Saving.” Basically it seams like you have won the game. Okay, maybe you haven’t won yet, but you are definitely kicking its butt. Why take on the added risk especially with Roth space that you can never get back if lost?
You are absolutely right that not only is this asset class completely optional, it is also very risky and the risk is not yet completely understood. We really don’t know how it is going to perform in a terrible recession. Defaults are almost certain to go up and that will hurt your return. As far as the “you have to keep buying to keep returns high” concept, that’s just hiding what your return really is. Your return isn’t as high as it at first appears because it takes time for a default to show up, even if the borrower never makes a payment.
Lending Club and Prosper are running a business. They make money whether the notes default or not (basically 1% of all payments made). If you would like to get into that business, either start your own P2P lending company or buy their shares when they go public. That equity investment is totally different from the fixed income investment being discussed here. It’s basically the same question of whether you would like to buy shares of Bank of America or Morgan Stanley, or buy a wad of mortgage backed securities that bank put together. The two investments are different with different risks and return possibilities.
Regarding rebalancing- you are correct that it is ideal for you to be able to rebalance from an asset class that goes up in a terrible equity market crash rather than one that also went down or didn’t go up much. In the past, I have simply rebalanced using new contributions. At some point, my portfolio will be too big to allow me to do that after a big market crash. But keep in mind I also hold some very safe fixed income investments including TIPS and the TSP G fund. That’s where I would go first in the event of needing to rebalance into equities. I agree that terrible economic times are likely to hurt both equities and P2P Loans, although perhaps not to the same degree. It’s really the same issue you see in buying corporate or junk bonds, just to a larger extent. Those who worry about this issue (such as Larry Swedroe) tend to keep their fixed income very short term and very safe. Those who do not (such as Rick Ferri) tend to use fixed income investments with higher expected returns. I guess I fall into the second group a little more than the first, but see the merits of both arguments.
Regarding my own personal situation, you seem a lot more worried about it than I am. I put P2P Loans on the fixed income side because they’re fixed income, even though they’re far more risky than my other fixed income asset classes (and perhaps more risky than some of my equity asset classes.) The concept of “winning the game” is an interesting one. I guess if I could take all my money and put it into treasuries, and be able to buy everything I want forever, then I would have “won the game” and have no need to take significant risk in either equities or fixed income. That is different from the concept I discussed in “being done saving.” That all assumed that I continue to earn strong returns on my money. If I want to stop taking significant risk with my portfolio, I’m nowhere near done saving. My projections generally call for a 5% real return. Although I’m beating that so far, it has required significant risk to be taken on by the portfolio. If (?when) we have another market crash similar to 2008, I expect to lose 30% or more of my retirement portfolio, just like I did then. The reason I take on added risk is in hopes of higher returns. Why do you take on added risk?
As far as “why Roth”, P2P Loans are very tax-inefficient. So I want them in a tax-protected account. My tax-protected accounts consist of Roth IRAs, the TSP (no P2PL available), my 401(k) (no P2PL available) and my HSA (no P2PL available.) That’s why they’re in Roth. Is Roth space valuable? Sure. But P2PL only use a small portion of it and so far, their solid returns are helping me increase my Roth space relative to the rest of my portfolio!
As LendingClub prepares to take the company public, we at EquityZen have been thinking about the company’s remarkable growth — and how it’s become the largest P2P lending platform in the world. We created a helpful infographic that tracks LendingClub’s growth and decomposes the capitalization table: https://equityzen.com/blog/lending-club-path-to-ipo/
Please let us know if you have any thoughts.
Thanks for sharing. That was quite an IPO pop wasn’t it?