Today is the five year anniversary of opening my first p2p lending account. It was June 11th, 2009 when I opened my first Lending Club account. Little did I know at the time but the moves I made back then would profoundly change my career and my life for that matter.
First some back-story. I came across an article about Prosper back in 2008 but by the time I checked them out they were in a quiet period and not taking on new investors. I remember literally tearing the page from the magazine (I think it was Money magazine) and saving it. I kept checking back every couple of months but Prosper remained in their quiet period.
By June 2009 I was getting impatient and decided to do a little research. A simple Google search quickly led me to Lending Club. They were open to new investors so I signed up for an account on June 11th, 2009. The very next day I received this email from Lending Club – my account was open and ready to be funded.
It was a few weeks before I got around to transferring my money in and making my first loans, so I didn’t officially begin investing until the following month. But five years ago today was the day I decided to give this peer-to-peer lending thing a try.
My Five Practical Lessons
I have learned so much in the last five years that it could easily fill several books. But my education didn’t really kick into high gear until I started writing this blog back in November 2010. Since then, I have written over 500,000 words here and have received at least double that number of words in the comments section. This, as well as the tens of thousands of emails I have received, has enabled me to learn from a huge cross section of people interested in this industry.
But in this post I wanted to distill all this learning down to five key lessons for investors. These are practical lessons for all investors, both new and experienced.
1. The number one rule of p2p lending: diversify
I didn’t understand this lesson when I first started investing at Lending Club. With my first $10,000 I invested in less than 100 loans. When some defaults hit my account my returns went down to the low single digits. What I should have done with that $10,000 is fully diversify the investment into 400 loans – I should have used the $25 per loan minimum to my advantage. This is my number one rule for new investors: unless you are investing more than $10,000 stick to the $25 minimum per loan. This will minimize the impact of any note that does default.
2. Analyzing the loan history can help increase returns
Back in 2009 there were no third party statistics sites that analyzed the loan history of Lending Club and Prosper, although you could do it yourself by downloading the loan history to Excel. Investors are so fortunate today to have several different, easy-to-use options in this area. The leading site today is NickelSteamroller.com and I recommend all serious investors spend several hours on their site learning about the wealth of data available. To help get you started you can read this extensive review from LendingMemo about NickelSteamroller. What Nickelsteamroller allows you to do is analyze the entire loan history of Lending Club and Prosper very easily. You can setup filters on this history to see which pockets of loans have performed the best in the past. You can then use this information to direct your investing today.
3. Higher yield loans have produced the best returns
Once you spend some time on NickelSteamroller you will soon realize that the highest interest (and highest risk) loans have historically produced the best returns for investors. Now, as investors we should realize the past performance is no guarantee of future success and I want to emphasize this one point. If we have a repeat of the financial crisis of 2008-09 or just another recession then it is quite likely that the highest interest loans will perform poorly as a group compared to the lower risk loans. By focusing your investments in the highest interest loans you are essentially betting that the economy will remain in decent shape for many years to come. I invest most of my money this way and I am comfortable taking that risk.
4. Automation is better than doing it manually
When I first started investing most loans stayed on the platform for several days at a time. You could read loan descriptions and ask open ended questions to every borrower you were considering for an investment. Today, those two options no longer exist. While you can still invest manually on Lending Club and Prosper both companies now have APIs that allow for automated investing. You can take these APIs and develop your own order execution system or you can use NickelSteamroller, LendingRobot, Bluevestment or other services to invest on your behalf through the APIs. This allows for a set it and forget it type of investment. I should also mention that both Lending Club and Prosper have their own internal automated investment tools as well but I have found investing through the third party APIs to be superior.
5. An IRA account is the best way to invest
One of the disappointments I have found about investing in p2p lending is the tax treatment. The bottom line is this. All the interest you earn is considered ordinary income but, of the defaults you receive, each year you can only deduct a maximum of $3,000 in losses (assuming you have no other capital gains or losses outside of p2p lending). This will probably not be an issue for smaller investors but for large investors it can really eat into returns. The solution is to invest through a retirement account such as an IRA. This way you can defer taxes (or pay no taxes in the case of a Roth IRA) on the interest earned. For this reason I am only adding new money to Lending Club and Prosper through an IRA.
These are my five practical lessons for investors gleaned from five years of investing. I continue to be focused on these lessons as I turn my attention to my next five years of investing in p2p lending or, as it is now known, marketplace lending.
What other lessons do readers have? As always I am interested to hear your comments.