April is officially Financial Literacy Month here in the United States so with that in mind I am providing this resource for new investors in Lending Club and Prosper. While many of these principals apply to investing in marketplace lending more broadly I am focusing on these two companies since they are still the two best options for non-accredited investors. Below are what I consider to be the most important success factors for new investors.
- Diversify Your Investment
When you decide to take the plunge and open an account at Lending Club or Prosper the temptation can be to put your money to work quickly. But far more important than that is to diversify properly. The minimum investment is $25 per loan so if you invest $5,000 then you can and should invest in 200 different loans. This way, if any loan defaults right away you can only lose 0.5% of your investment. My rule of thumb is that I don’t increase the note size above $25 per note until my balance is more than $10,000. To learn more you can read the dedicated pages on diversification at both Lending Club and Prosper.
- Expect Defaults
A friend of mine emailed me the other day asking me what was wrong with his account. He started off with Lending Club last year and was earning more than 12% investing in a selection of A, B and C-grade loans. Now, his account has passed the year mark and he is down below 8%. The fact is that nothing is “wrong” with his account. He has just had a bunch of defaults and while that it is always disappointing it is also completely normal. Even if you invest in only A-grade loans you will almost certainly experience defaults at some point. Every time you place an order both Lending Club and Prosper provide you with an estimated default rate and an expected return. You should take more notice of these numbers than the yield on the individual loan. Lending Club also has a great resource tool that shows how you compare to other investors with a similar risk profile. This can be useful for knowing that others are having a similar experience to you when it comes to defaults.
- Keep Your Cash Balance Low