Over the last few years I have been a cautiously optimistic, relatively early adopter of investing in unsecured peer to peer loans. I first start dabbling by opening small taxable Lending Club and Prosper accounts in late 2011 and early 2012 respectively. After promising initial results on those tiny amounts, in the Fall of 2012 I began making substantial investments in Lending Club notes via a Roth IRA as this investment not only has high expected returns, but also is maximally tax-inefficient. Eventually, I would dedicate 5% of my portfolio to the asset class, almost all of which was in that Lending Club Roth IRA account. I felt like I did my research and was quite aware of the various risks associated with the investment and felt the probable rewards were worth the risk.
My returns in the asset class were quite good over the years. My XIRR spreadsheet shows the following returns:
- 2012: 12.7%
- 2013: 13.2%
- 2014: 11.3%
- 2015: 10.0%
- 2016: 7.1%
for an annualized return of 9.9%, which was certainly higher than the average investor on the platform was seeing. The low correlation with the rest of my portfolio was also a major benefit. The hassle factor was not insignificant, but I eventually found ways to automate it. As a financial blogger, I was given free access first to the services of Interest Radar and then to the services of NSR Invest. They both worked a little bit differently, but each was useful for my primary purpose of not having to manage each individual $25-50 note manually.
Over the years, the platforms began to be more and more dominated by larger firms and the only way to buy the “good notes” was to either pay one of those firms or otherwise have a computer buy them automatically for you. But my returns were still within the 8-12% range I felt I needed to be getting in return for the risk I was taking. So what happened to cause me to want to leave Lending Club? There were a number of factors.
# 1 Desire For A Simpler Portfolio
Long-term readers are familiar with the portfolio we've been using for years. It's not perfect by any means but sticking with it has served us well. The only real change made in the last decade was substituting these P2PLs for a few of the bonds in the portfolio. However, as discussed in an upcoming post, I'm finally biting the bullet to simplify the portfolio significantly. As I've said many times, I think three asset classes is the minimum in a diversified portfolio and I think there are real benefits in increasing that to about seven asset classes. There may be some minimal benefits in going from seven to ten, but beyond ten (like my portfolio) you're really just playing with your money.
# 2 Less Hassle If I Die
One great benefit of a simplified portfolio is that it is easier for your heirs and/or their financial advisors to sort things out when you die. If I were to die today, all of the asset classes I invest in would be relatively easy to liquidate and deal with except for my investments at Lending Club and Prosper. I simply don't want my wife to have to deal with this hassle. Now, I thought about this up front. In fact, that was a major reason why I opened that Roth IRA at Lending Club instead of Prosper (because Lending Club let you sell late notes and Prosper didn't.) Back then you could relatively easily sell your notes, perhaps over a week or two, and move on with your life. What I have discovered since I started to liquidate my notes is that it isn't nearly as easy to do so as I had hoped, and it appears it has become significantly harder than it was a few years ago.
Untracked powder is always worth the price of entry
NSR Invest has a relatively new and slick feature that allows you to sell your notes at a range of prices automatically. It was implemented shortly before I decided to liquidate and I've been very grateful for it. What has been disappointing, however, is just how slowly those notes sell, through no fault of NSR Invest. Now most of my notes are good notes. They've given me great returns and are current. But even so, the market for them seems pretty thin. As of the time of writing this blog post, I've had all my notes on the market continuously for over two months at various prices. I was able to sell a few at a premium, but not nearly as many as I expected. I was able to sell more at par and even more at slightly below par. But after three months, I've only managed to sell about 70% of them (about $32,000 worth.) I'm getting close to having my initial investment back (about $34,000) and I've still got $14,000 worth of notes. So the final returns on this investment aren't even close to in. Interestingly, the taxable account notes sold a lot faster than the Roth IRA notes. I think part of the issue is that the sub- $25 notes sell a lot better than the $25-50 notes that constitute most of my investments since I went to NSR Invest. Another minor issue with the NSR Invest selling feature is that they don't let you sell notes for more than a 60% discount and nobody will buy notes that are 3 months late without a larger discount. In fact, it's pretty tough to sell late notes at all. I probably won't be discounting notes any more than I've already done and will just let payments trickle in for years at this point. My rollover back to Vanguard for 70% of the investment should take place any day now (I hope, they're really slow right now.)
In addition, Prosper decided last November that it wasn't going to let you sell your notes at all. It used to be they just didn't let you sell the late ones, but by the time I decided to liquidate, it was no longer an option. It looks like I'll be a Prosper investor for the next 5 years too whether I want to be or not. No big deal, it's only $500, but it's still a bit of a hassle to have no secondary market for those.
A more annoying feature of this liquidation is trying to decide how much cash drag is worth paying extra transfer fees for. While there are no fees to get into Lending Club and its chosen IRA Provider Self Directed IRA Incorporated, there is a $100 fee for a partial transfer out and a $250 fee to close the account. Now these were all disclosed and I was aware of them, but I had hoped to just have to pay the one time $250 fee when I eventually left. Now that it looks like full liquidation will take years, it's probably worth paying one or two of those partial transfer fees to minimize the cash drag.
There are several investments in this asset class available to accredited investors that allow you to not only spread your investments across multiple platforms but also to really minimize the hassle in this asset class. However, the minimums on them are $250K+, which was four times what I was willing to dedicate to the asset class at this point in my life.
# 3 Dropping Returns
While my returns have been quite good over the years, the overall trend is not encouraging, particularly in the last year. Now, whether that should be blamed on my switch to NSR Invest, on the shenanigans at Lending Club, on the maturing of the asset class with the entry of institutional players or what, the fact remains that returns are dropping out of the range that I expected for the risk I was taking (8-12%.) My current returns for this year so far are -1.3%, but that's mostly due to the fact that I've sold some notes at a discount.
# 4 Cockroach Theory
As I've discussed many times over the years, the main risk with P2P Lending is platform risk. I always knew that a certain percentage of borrowers were going to default. That was all baked into my projections. I expected a high default rate, but when you're getting 18-30% interest on the notes, you can afford to have a lot of them default and still get a great return. Platform risk, i.e. the risk that Lending Club goes out of business, was the more worrisome risk to me due to the way this is all structured. In 2016, there were a few “cockroaches” that became visible at Lending Club. It turned out the CEO, Renaud Laplanche, and his family had been borrowing from the company to make it look like its volume was higher in order to attract outside investor money. That wasn't a huge deal financially, except for the loss of trust. Then there was a finding that proper accounting standards weren't being followed with one account. Lending Club made it right and fired Laplanche, but it seemed two cockroaches had snuck out from under the counters and it made me wonder how many more were under there, especially considering that Lending Club was the flagship of the peer to peer lending fleet. Other investors and perhaps even the borrowers have surely been wondering the same thing and perhaps that's why my returns dropped for 2016 and perhaps that's why I'm having a harder time liquidating than I anticipated.
At any rate, I found myself wanting to watch and see what happened rather than contribute more money to the account. For month after month I delayed my periodic Roth IRA rollover to the account. It was slowly becoming a smaller and smaller portion of my portfolio, well less than the 5% my investing policy statement committed me to put in there. Then one morning in the Fall I found myself waking up early and thinking about my Lending Club investment. Two or three days of that and it was decided. I don't need investments I lose sleep over. If I was unwilling to commit additional capital, I probably shouldn't leave the old capital there either. After discussion with my wife and our obligatory three month wait dictated by our Investing Policy Statement, we decided to start liquidating.
# 5 More Attractive Investments
Another factor that played into our decision was the appearance of more attractive investments for our money. As regular readers know, the last couple of years I've been dabbling more and more into real estate. While we aren't particularly interested in direct ownership and especially management of income properties, some of the syndicated and private fund options meet our requirements for high returns, low correlation with our stocks, bonds, and even publicly traded REITs, and acceptable amount of transparency and liquidity. In fact, most of the crowdfunded platforms routinely offer 9-10% 1 year hard money loans backed by the property itself. We figured if we can get 9% on a loan backed by an asset, why would we invest in an unsecured loan that was only giving us a 9% return, especially with all of that hassle? As we simplify our portfolio and dedicate a slightly larger portion to real estate, that portion had to come from somewhere and the P2PL allocation seemed an obvious place for some of it.
# 6 Little Synergy With The Blog
One of the things I had hoped would occur as I wrote periodically about my Peer to Peer Lending experience was that it would provide a little boost to the blog income. I have an affiliate marketing deal with both Prosper and Lending Club such that if a reader opens an account after going through my links I get a small commission. I've learned two things about affiliate marketing deals over the years, however, both of which severely limited the amount of income I earned from Lending Club and Prosper.
- The purchase has to be essentially a no-brainer. In any affiliate situation, I'm going to write about all the negative things I know about because I want to be fully transparent with my readers. But if you write about a bunch of negatives, nobody signs up for the deal. So, no surprise, I never had very many takers with this deal.
- I have to be able to offer something special to the reader that they can't get by going directly to the company's site, like the bonus money for refinancing your student loans. I had nothing to offer that was unique with the P2PL sites.
At any rate, the bottom line was that Lending Club and Prosper affiliate commissions never really amounted to much and I've become much pickier about future affiliate partnerships.
In conclusion, investing in Peer to Peer Loans did work out well for me. My overall returns were not only positive but impressive. It was far more hassle than I ever expected, both getting in and getting out. And when the real risk actually showed up, it bothered me a lot more than even the 2008 stock market downturn.
What do you think? Did you ever invest in P2PLs? Why or why not? How did you do? Have you made any changes due to the events at Lending Club in 2016? Why or why not? Comment below!
I’ve known about Lending Club and Prosper since their early days, but never chose to invest in it. It just felt like such a hassle for good, but not great returns.
Not surprisingly, as the industry has matured, people have exploited any inefficiencies within the P2PL market. I doubt that you can currently make any increased risk-adjusted return on the platform. If anything, an uneducated investor will probably lose money on a risk-adjusted basis because they are taking the unprofitable loans while the pros are taking the profitable loans.
It’s like looking at houses on Zillow. The houses that are underpriced are quickly bought up, while the houses that sit on the market for weeks and weeks are overpriced, but fill up the search pages on Zillow. An unsuspecting buyer may not know any better and overpay for one of these houses.
Good move. Simplicity nearly always trumps (ouch!) complexity. I agree that three asset classes is fine, up to seven if you really understand the issues and can handle the tracking error, but definitely no more than that.
I looked at Lending Club in 2009/2010 in my day job. I tried to create access to a pool like we had done in commercial middle markets loans, a great space post- Dodd-Frank. They are very analyzable, unlike P2P.
My conclusion then is that P2P is much riskier in single notes and still riskier in pools. They were also arrogant and I generally run from that. The platform jiggle isn’t a surprise, unfortunately.
You had a remarkable run. Well done!
Which crowdfunding company are you using? I’m interested in pursuing real estate through crowdfunding. I’ve heard too many horror stories of unsavory renters to actually get an investment property of my own. I’m also interested in what you are looking for in your crowdfunding investments. As in property types and regions of the country your investing in.
The nice thing about the crowdfunded real estate space is there are 100 companies doing it and probably a dozen that are doing it reasonably well and will stick around. Much better than the P2P Loan space as far as diversification.
Those returns look ok until you compare them to S&P during that time:
2012: 16.0%
2013: 32.3%
2014: 13.6%
2015: 1.4%
2016: 12.0%
It’s easy to make money during a bull.
Right, but the money wasn’t in stocks. It was in an asset class with very low correlation to stocks. That was the point of adding it. Stock like returns and low correlation.
I’m not sure you can say low correlation. More like we have limited evidence that it’s correlated.
Fair enough. The evidence is definitely limited. But what evidence we do have suggested low correlations as you would expect given the significant theoretical differences between stocks in publicly owned companies and loans to random borrowers.
Low correlation but certainly not low risk. And I imagine the deep risks to the stock market would affect these high risk borrowers pretty hard…
Agree. It was never low risk and I certainly never pretended it was.
Inspired by WCI and other personal finance bloggers, I entered P2P lending, via Lending Club, about three years ago. I never had much in the account (topped out around $6000) and decided that it was not worth the hassle, especially in a taxable account, especially considering dealing with the loan write-offs around tax time.
I agree that the crowdfunding real estate space is potentially more rewarding, and I have participated via PeerStreet and RealtyShares. So far, so good, although the crowdfunding is getting a little bit crowded and difficult to find suitable opportunities.
Seems like a smart move to cut your gains and leave Lending Club to avoid the hassle. The returns don’t seem like they are worth the additional risk. These platforms weren’t mature during the Great Recession, so it’s an open question whether defaults and returns will fall off a cliff during the next recession.
The platform risk was the dominant reason I decided against pursuing P2P as a part of the portfolio. My understanding is that it is not possible to structure the loans otherwise, i.e. LC/Prosper etc actually own the loans due to legal requirements.
Based on the WCI recommendation, I decided to invest $2500 in the Lending Club. I started to liquidate last year for the following reasons:
1) I never felt that I had good access to loans to invest in. I always felt that the best loans were packages and sold off to large investors.
2) I found the process of selecting loans to be very cumbersome. I would invest in 60 loans today and find out in the next week only 40 went through. It took me longer to invest $1000 in the Lending Club than to manage my portfolio which is significantly larger.
3) Tax time was a hassle. So much to report for so little return. It was not as cumbersome as investing in LLPs but it was a hassle.
4) When there are financial irregularities that make you question the integrity on upper management, it is time to hit the road. Over the years, I have a significant amount of money by identifying publicly held companies with financial or ethical issues (think Tyco). I would buy put options and wait for the inevitable. I would NOT go long on them.
Maybe I am getting too old but when I hear the term “disruptive technology”, I start to think – “OK, what rules are they breaking, what corners are they cutting. Maybe that is a bit cynical but new technologies always make some excuse to exempt themselves from the most sound business regulation.
You’re absolutely right jlawrence01, at the time of tax return, for little return one has to do long processing paperwork.
I have a portfolio of $50,000+ with Lending Club.
Pretty aggressive in which the expected rate of return exceeded 10% according to Lending Club estimates.
Last year my return was 3.21%.
After reading this blog I have started to reevaluate my situation and will be making decisions soon to about my portfolio.
I am disappointed at the performance and am concerned that when the economy heads south I will be left holding the bag.
You mention “substabtial” investment. How much of your total money was in P2P?
At most it was 5% of my retirement portfolio.
Yeah doing P2P via a taxable account is a major pain (think I entered over 75 entries for Prosper this year, Lending Club finally has an integration w/ TurboTax but not with Prosper). After doing that the first year decided to stop and now on the slow process of draining my money out of Prosper which will be in 5 years 🙁 — like watching grass grow.
I also got into RealEstate Crowdfunding and it’s a bit better as it’s more “secured” as it represents an interest into a physical property vs some guy’os promise he’ll pay you back for getting a loan to buy a boat. Doing the usually suspects: RealtyShares, RealtyMogul, FundRise, RealCrowd and CrowdStreet. If you want to do debt (although equity has some tax deferral benefit) then looking into some of the eREITs funds are interesting: RealtyMogul and FundRise are moving that way. There is a new aggregator Alphaflow which is interesting not only does it aggregate deals from some of the major Real Estate CF players but it also lets you track performance (almost like a Mint or Personal Cap but for RECF). What’s most intriguing is they have a diversification fund that invests 75-100 debt deals across different platforms (so minimizing platform risk) and you only get a single tax form (and after going through Prosper less paperwork is better!) but the best part is their 1% fee only is charged if they hit their yield target of 9%, Now if you could just get managed funds to do the same!
The issue, however, is with debt it counts as interest income which gets taxed as ordinary marginal rates. So if you’re in a high tax bracket then it’s not too attractive (rather just do a tax exempt fund). Could do IRA (to help with taxes) but requires going through a 3rd party which usually have maintenace fees associated. I like equity better for the tax benefit but requires a lot more research and investment.
The whole fintech space is constantly involving and there’s always the “new shiny” stuff that everyone is attracted to (they need to create new products to get investors). I do wonder that at the end of the day if I could have still done the same if I just did the simple Buffet way with a low cost index S&P fund but what would be the fun of that! ;)…
I’m not so excited about the eREITs given the history of privately traded REITs (a product made to be sold, not bought) and the ease of buying all of the publicly traded REITs via the Vanguard REIT index fund.
Interesting. I’ve seen other FIRE bloggers abandon this as well, so it looks like P2P lending just isn’t something as viable as other investments. I know some people who swear by them, but in my experience I wouldn’t trust people enough to do P2P lending for iffy returns.
This is pertaining to the first part of the article….I will be attending the AAOS meeting with my husband, who is a fellow, in March. Are we both able to go on the cruise? I would love the opportunity to hear more about finances from you! Thanks.
Yes. Looking forward to meeting you! Be sure to RSVP using the link.
Over the past four years, I have had great returns with Prosper, (15% seasoned according to Prosper) but started withdrawing my funds since last summer. The first red flag was when defaults started to skyrocket, but my stated returns didn’t change. I don’t know if they started using “creative” accounting methods, but the numbers stopped adding up. My decision to pull out was confirmed, when Prosper decided to end the secondary market trading in the fall. I communicated with them through email about some of my concerns, and their response felt like a complete blow-off of my concerns.
Although I am pulling out, I am not giving up hope completely. If things start to look better in the next few years, I won’t withdraw completely. Unlike some posters, I haven’t found the note selection process to be time consuming at all. After an initial investment of time backtesting different criteria on NSR, I automated everything and only spent a minute or two a month checking returns.
Don’t necessarily believe the company’s estimate of your returns. The ones I report are my actual XIRR returns. The company’s reported returns are routinely higher.
WCI is absolutely right. The returns Prosper reports are pure fiction in my experience.
Yes, you definitely have to calculate your own.
I’ve tried a couple of times to figure out how Prosper comes up with their posted returns. I can’t make the math work out no matter what I do. Using XIRR function in Excel yields vastly lower returns…nearly zero in my case.
I think the problem you’re seeing with Prosper is called “lying”.
Since I don’t know the intent of Prosper, I cannot know if they’re lying or just incompetent. Either way, I want nothing more to do with Prosper.
$34K in and $32K out is a negative return in my world. You still haven’t even reached break-even on the investment. The way you’ve positioned the returns is *very* common in the angel investing world though.
Startup offers a $100K promissory note with regularly scheduled interest-only payments or royalty based payments over five years with a ballon payment. Investor claims an amazing 10-15% annual return based on the incoming checks, but company goes bankrupt in five years and investor loses the entire $100K in principal. The returns sound great compared to anything else (since only traders factor in investment risk), but it’s an overall loser.
I’ve actually had arguments with people who truly believe they’ve made great returns despite their bank account being lower. That’s not the case with WCI, yet a surprising number of people miss the reality that they’ve lost money. More financial psychology at work here.
Unless you’ve previously cashed out positions that generated real returns of almost 10% over the prior years along with returning the initial investment?
Give me a break. That can be said about any stock in the market and the stock market as a whole. “You haven’t yet sold so your return is negative.” That’s silly.
I do feel better about having my principal back though (just about.)
The stock market is reliably liquid. Unlike most alternative investments, you can cash out any public company position within seconds or minutes. As you’ve already discovered, it’s usually much harder to quickly get out of non-mainstream investments including private loans, penny stocks, real estate, antiques, tax liens, etc. at face value.
If you think a $100K private note is equivalent to $100K of AAPL (Apple, Inc.), we will simply disagree.
Chris does have a point considering you did mentioned that you are having a more difficult time than expected getting your money back and even having to discount some notes to make the sale. Although you are likely to sell more of those notes, we still don’t know if you will sell all of them or for the price you are expecting. Don’t get me wrong. I hope you get every penny and then some as I wish you nothing but limitless success. The reality is we have still yet to see what your true return has been on this investment. I am curious and hope to hear a future blog post once you get everything or almost everything sold.
Also, regarding P2P being an uncorrelated investment with equities. I would agree to some extent, but my belief is that they are more correlated with the actual market than they are with Treasuries. Maybe somewhere in between. I am really curious what will happen to those investments during our next recession.
Thanks for doing this experiment and sharing your results.
I think you’re mistakenly equating them to corporates where the bonds contain some equity risk. These have a totally different set of risks.
I’ll be sure to report returns when I’ve finally liquidated.
The late loans are sold at a heavy discount (but I’ve assumed a heavy discount when valuing them for years.) The current loans are sold for a slight premium, par, or a slight discount. I’ve assumed a par value on those when valuing them.
I’m not sure that’s comparing apples to apples. A stock should be efficiently priced so you can assume at this moment the asset is worth it’s price and can be sold for as much. Unless I read incorrectly, you told us your loans (the ones that were selling) were selling for below par. If the P2P market has priced them lower, isn’t your expected return lower?
Yes. And I’ve adjusted for it in my returns. Whether my adjustment factor is adequate or not is a different matter.
I took the plug into P2P lending about 4 years ago but being in Texas I didn’t have access to the loans on opening. I could only buy them on the secondary market at Lending Club. I only bought loans that were current and had a diversification across B-F investment grades. It seemed like as soon as I bought them they started to default. My initial year return was -9%. I started liquidating what I could after that but once I sold the good loans that were still current I really couldn’t sell the ones in default. I just let those ride and some came back current and the rest defaulted. Thankfully I only put $5000 total in the account but I must have been on the worst end of the bell curve.
It’s pretty difficult for me to buy anything but index funds at this point. Just too easy but real estate does have some appeal.
#2 Less Hassle If I Die hits home. My late grandfather died a few years ago and was heavily invested in Lending Club. He looked for loans first thing in the morning and last thing before he went to bed and considered it his primary source of income. He thought he was making a pretty penny, but, as it turns out, he wasn’t.
When he died suddenly, my widowed grandmother was stranded, had no idea what he was invested in, and trying to figure out how to get the money back. Turned out his system for finding good notes found more losers than winners. In the end, the estate lost a substantial amount through bad loans and trying to get the money out of Lending Club. The whole situation added a lot of grief for the family.
I’m pulling money out of LC for the same exact reasons you mention above. It will take me a year or so to get my investments there down to $50k, and once I hit that point I may even go lower.
I’m getting better returns at Prosper and will let my $25k there ride for now.
Not having a tax advantaged way to use these I always felt like they were way too much trouble and risk for the after tax returns. Glad to have missed the boat as these issues started coming to light this last year.
Me too. I was even beginning to think that I would do this in my free time when I cut back more on work.
I should add that I made more money in 36 hours with the Lending Club (LC) stock IPO, which was made available to investors in notes, than I made in several years of tooling around on the site and using it as it was intended.
That’s pretty good timing to make money on that. It’s lost 80% of its value for its long term investors.
fractional realty is no haven from P2P lending-
POL is garbage, no penalties for late payments nor early pay offs, plus deadbeats that pay nothing leaving months to years for foreclosure to yield your principal if ever
RS is equity mostly so cant say until a few more years hence if worthwhile
Im in low six figures with these two and feels like just playing with money really also
I am KEEPING my account. I don’t use NSR or whatever robot. 10+% returns for 5 years going strong. It took a “dip” this year but I am still getting 10+%. Wrote my own selection algorithm that I have refined overtime.
I won’t have accredited status another year or so; but I LOVE P2P lending. It is monthly cash flow and I reinvest it back for a true compounding effect that is tough to achieve in the market because dividends aren’t coming in monthly and simply the amortization of money reduces the maturity of this fixed asset.
I have been happy and will continue to invest.
I have used lending club for 3.5 yrs, but recently the default rate has been significantly higher for more recent loans. For about 6 mo I have been gradually withdrawing rather than reinvesting. After your post I checked the lending club loan stats, for loans in the FG category the adjusted annualized return are actually negative for loans from 2015 Q3-4. If this was a temporary error that’s been resolved, I might stick around, but likely will continue to withdraw and use something with less hassle factor.
I put in $25k. Invested it for a couple years. Stopped reinvesting and eventually sold my riskiest loans, were I was getting so many defaults my effective return was $0 pre-tax. Worse, I was paying regular income tax rates on the interest, but only getting capital losses on defaults. Terrible deal.
I did find that the least risky loans where I used a robot service, performed better than expected.
But add up the tax disadvantage, fees, complexity, and hassle, and I sure wish I’d skipped the whole thing and just left it all in a money market account.