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How To Invest $500 in P2P Lending

by Peter Renton on September 19, 2013

I always talk about the importance of diversification and that investors need at least $2,500 and preferably $5,000 to be well diversified. But what if someone just doesn’t have that kind of money to invest? Should they even consider p2p lending?

While $500 is only enough to invest in 20 different loans I think it is acceptable to start here if that is all an investor can afford. But I think a conservative investment strategy is in order.

Invest in the Lowest Risk Loans

With only 20 notes you want to avoid defaults at all costs. If you get one default immediately you will have lost 5% of your original investment. That is very tough to recover from.

So, I would focus on the very lowest risk loans, which means A-grade loans at Lending Club or AA-grade loans at Prosper. While you won’t be able to earn double digit returns with this kind of investment you will reduce your possibility of defaults greatly. And if you are only investing $500 that should be your goal.

Take a look at this graphic below (click on the image to view it in full size). This is from Nickel Steamroller and it shows the returns on completed 3-year loans for all loan grades from 2007 through July 2010 at Lending Club. Take a look at the two numbers inside the red circles. A-grade loans earned 5.39% for investors, not a bad return. But the second column is even more important for a less diversified investor. The default rate on those loans was only 2.481%.

Lending Club Nickel Steamroller Completed Loans

Now, if I was making this investment I wouldn’t choose just any A-grade loan, I would apply some filters here to further reduce the likelihood of defaults. Let’s just take some simple filters anyone can use and apply it to this same batch of loans:

  1. Inquiries = 0
  2. Income >= $7,500 per month
  3. Loan type: credit card, debt consolidation

If we run the same query with those three filters applied then you can see how the estimated ROI increases but more importantly in this case the default rate drops dramatically to 0.482%. Now, I should point out that the sample size here is pretty small – we are only looking at 113 A-grade loans from this period. But if you take a larger sample size by selecting a more recent time period you will see a similar trend. My point is that with some prudent filtering you can reduce your chance of defaults even with A-grade loans.

Lending Club Nickel Steamroller Filtered Loans

I truly believe that everyone should have a p2p lending investment account. Even if an investor only has $500 to invest they can get started. Then as they add to their account they can slowly expand their horizons beyond A-grade loans into some of the lower grades. But I think it would be unwise to do that until they have significantly more invested.

What do you think? I would love to hear some other opinions. If you only had $500 to invest what would you do?

{ 15 comments… read them below or add one }

BiggieC September 19, 2013 at 7:30 pm

Peter,
It is funny that you wrote this post because I myself started with $500 to test the waters. I’ve since added thousands to my account and am diversified into hundreds of notes. The notes I bought during my first $500 investment are mostly gone now either from being fully paid or selling them in the secondary market to reinvest them in lower grade notes. From what I remember I bought 18 A grade loans, 1 B and 1C . My thinking was similar to your logic – reduce the potential for defaults. I would give a similar recommendation to small investors to stick with A grade notes, especially the ones with the least amount of default risk!

Reply

Peter Renton September 20, 2013 at 8:15 am

BiggieC, I also started out with $500 many years ago but I wasn’t as smart as you. I invested in two A-grade loans for $250 each. And yes, you guessed it one of those defaulted after about a year.

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Martin September 19, 2013 at 9:58 pm

I started this way myself. Three years ago I started building my account with Lending Club with only 300 dollars invested and I was investing only in A or B grade notes. Today my account is almost 19,000 and I invest in F and G notes, since I am very greatly diversified (some 960 notes in total). To keep high diversification I strictly invest $25 per note, never more. Works like a charm!

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Peter Renton September 20, 2013 at 8:16 am

Good advice Martin. Sticking to $25 notes is the best way to go unless you have a very large account and by that I mean more than $20K.

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Neal S September 20, 2013 at 12:13 am

it’s tempting to look at the very low default rates and conclude that the $500 investor is unlikely to experience any defaults. Statistically, it’s not so.

Without the filters, there were 144 defaults out of 2847 loans or 5.06%. The chance of having at least one default in a portfolio of 20 is 1 – (1 – 5.06%)^^20 or 64.5%.

With the filters, there were 2 defaults out of 113 loans, and the chance of at least one default in the portfolio is 30%.

So, the strategy presented is excellent, but new P2P investors should not be surprised if they do experience a default. Anyone who is going to be upset by defaults should not be a P2P investor.

Reply

Peter Renton September 20, 2013 at 8:21 am

Very true Neal but there is one thing you didn’t mention that I also glossed over in the article. A-grade loans with high incomes are much less likely to default early in the loan term. That is why the total loss in the second table is only 0.482%. So even though there were two defaults out of 113 loans the loss to the investor was a smaller percentage than that because these borrowers made several payments before defaulting.

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Simon Cunningham September 20, 2013 at 2:07 pm

Dang. Nice article idea Peter. If a newbie like my brother wanted to try his p2p hand with $500, would you suggest he start with Lending Club or Prosper? I’m tempted to say LC for the long-term stability, but Prosper for the friendlier interface and hover-over definitions.

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Peter Renton September 20, 2013 at 3:49 pm

Hi Simon, I don’t have a strong feeling either way, they are both good choices today. Lending Club are obviously the industry leaders but Prosper has a little less competition between investors. I would have him look at both sites and see which one he prefers.

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CA-Lender September 26, 2013 at 12:12 pm

There is another way to get more then 20 notes with $500, after funding your Prosper or LC account, purchase small valued (<$25) notes on FolioFn, the secondary market.

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Peter Renton September 26, 2013 at 7:36 pm

Hi CA-Lender, I thought about mentioning the trading platform but decided it was beyond the scope of an introductory article for small investors. But you are certainly right. You could build a portfolio of 50 notes or more with $500 by shopping for seasoned notes on Folio – those notes that have 12-18 payments made.

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Hrant October 1, 2013 at 9:23 pm

Great article Peter, as usual:)
I started w/$50. only, approx 4-5 years ago, and am now in the tens of thousands $, w/thousands of notes.
Very time consuming, but am adding funds as needed, and am mixing mostly B, C,D’s and some E’s w/ $25. each allocation, which take a LOT of time.
The returns have been in the 10-11% range for one of the older portfolios, w/other newer approx.1 yr, riskier portfolio of approx. 15%…which I know will keep decreasing due to defaults, and inability to find notes on the platform of LC.
Have not been too successful to sell notes at face, or premium, at all, and have some sold at deep discounts on LC, as Prosper doesn’t let one sell any late notes. Thus have closed my Prosper account.
Keep up the great journalism, and information. Looking forward to new ideas, and investments all the time. Thank you again.

Reply

Peter Renton October 4, 2013 at 4:55 pm

Thansk Hrant, I appreciate the update and the kind words. Interesting you are still doing $25 allocation despite your large number of notes. Ever considered going to $50 or even $75? Should cut down on some of the time you spend and it you would still be very well diversified.

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Hrant October 4, 2013 at 10:59 pm

The only catch is that I sell notes…for a fraction of their worth if late. Some have come back, making the person’s who pick up my notes at a discount some money.
I am prepared to cut my losses, even if I get a portion of my investment.
Thought about $50′s, but then I still would be getting less for my resells, reducing my returns I guess…
I still can’t believe that this P2P lending really works, but, evidenced by my very positive experiences, it really does….now I’m busy adding larger funds weekly to invest:)
By the way Peter, I always give credit when and where due, and you certainly have had a positive impact on me, along w/a few others, indirectly w/your support and exposure of the P2P field.

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Faye October 4, 2013 at 7:04 pm

I’m an investor of 10 month at Prosper and around 5 months for Lending Club, and I started small. I invested $300 in each account. So far, no defaults yet. I do have one note that keeps on paying at least 10 days late. Earns me more interest, but I sure do hope he won’t default. Enjoying my experience investing. Just last week, I had an excellent experience borrowing from Prosper, too. I could share that with your blog, too. I’m excited about the investment possibilities with P2P lending.

Reply

Peter Renton October 9, 2013 at 1:47 pm

Hi Faye, Nice to hear from you and thanks for sharing your experiences. Sounds like you are off to a great start.

Reply

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