Looking for Diversification? try peer-to-peer lending.
For a while now I’ve been talking about the possibility of trying out a fairly new investment platform that I had absolutely no prior experience with: Peer-to-Peer lending. Typically an investment portfolio wouldn’t revolve around Peer-to-Peer lending, but once you’ve spread your assets properly across the traditional investment options (Mutual funds, stocks/bonds, etc) you may start to feel a tickle in your stomach; you may want something a little more exciting than the boring old stock market. And you may want to help other real people out in the process.
A few of my blogging buddies have boasted about their fantastic returns through P2P lending sites (including MMM and Mr. 1500). There are two fairly large companies that specialize in P2P lending (which I am going to henceforth refer to as “social lending”): Lending Club and Prosper. Lending Club is the mack daddy king of the social lending world. They’ve funded over $2 Billion in loans and their business has tripled to quadrupled every year since 2008. Pretty impressive stuff!
Lending Club may be the boss, but I was drawn to his little brother, the up-and-coming social lending site: Prosper.com. With an impressive membership of over 1.8 Million users, Propser has been able to socially fund over $570 Million in loans to date.
How does prosper work?
The process of signing up for an account was so easy that I don’t think it needs to be discussed here. But — once your account is set up and your bank account is linked, this is where the real magic starts.
The investor dashboard is easy to navigate and is thankfully ad-free, unlike some other great personal finance sites (I’m looking at you Mint!). Being investors, the main thing we want to look at is the “Browse Listings” tab. Here we can see all of the loans that are awaiting funds from investors. There’s a handy search feature that let’s you filter out certain “Prosper Ratings”. Prosper Ratings are a rank from AA (the least risky) down to HR (which stands for High Risk).
Similar to the rest of the investment world, the higher the risk, the higher the potential returns. Prosper is a straight shooter when it comes to their potential returns models. They don’t say that you’re going to earn 11.5% on your investment when they know that some borrowers do in fact default on their loans. Instead they promote “Seasoned Returns”, which accounts for the x% of people that default on their payments, based on statistical data. The graph to the left shows the return you could expect to receive per Prosper Rating class.
To make the idea of social lending easier to comprehend, I’d like to relate the core principle to that of mutual funds (I know it’s a stretch, but I feel like they have at least one commonality). When you invest in a mutual fund, you reduce the overall volatility of your investment, because instead of being bought into individual stocks; the fund will be comprised of hundreds or thousands of companies’ stocks. This reduces the volatility, because if one of the represented companies goes bankrupt, the fund may suffer a little, but you wouldn’t lose everything. The same is true with social lending. You don’t log into your Prosper account looking for someone who needs a loan and fully fund the thing — because if you do, you’re going to lose quite a bit if they decide to not repay the loan. Instead, you buy notes (portions of loans). So — if you have $5,000 you may decide to purchase 50 x $100 notes, each from a different loan. Volatility: reduced.
New social lending investors, start here:
Having a brand new account, I don’t have any impressive data-graphs to show you. I’ll return to social lending in the future when I can either brag about how I’m making money hand-over-fist, or how I lost my shirt. Social lending will remain a very small percentage of my overall portfolio for a while, but I think it’s a necessary form of diversification in the Modern Era. And since people need loans, why shouldn’t I help them out in the process. Banks totally suck, amirite?
What if you’re looking to borrow money?
Prosper doesn’t just offer a hot way for investors to rake in serious cash, they also offer a great way for borrowers to obtain loans that they may not be granted by a bank. To obtain a loan, a borrower would submit an application which includes a credit check, and the reasons you need the loan. After the request is created the loan will sit in a sort of “loan marketplace”. Here investors will be able to review your application and choose whether they’d like to help you with your cause. If you’re looking for a loan, try out Prosper’s borrowing service and just remember that your new loan isn’t coming from a shitty “too-big-to-fail” bank; it’s coming from real people.