This is a guest post from Eric Rosenberg at Narrow Bridge Finance and author of the Personal Finance Arsenal, an eBook designed to help you save time, save money, build your credit, and avoid the big fees.
I recently visited the homepage of Lending Club, a regular online stop for me, and noticed a big graph on the front page. They say that 91% of investors earn 6%-18% returns on portfolios over 800 notes ($20,000+). That got me to thinking, could someone use a p2p lending cash stream as an income source in retirement?
The Weighted Average Return
As with most marketing statistics, the ad leaves a lot up in the air. I assumed that the average return of the 91% making 6%-18% is in the dead middle of that range, which is probably high. Assuming that, however, I get a weighted average return of 11.3% across the 800 note club.
Just to be safe, I wanted to do a little sensitivity testing. I also ran a 6% return, 4.5%, and 1% scenario. This analysis assumes 100% principle reinvestment and 100% withdrawal of interest returns.
Cash Flow Possibilities
Depending on your lifestyle goals and portfolio size, you can make a lot of money on a p2p lending platform. According to the Lending Club test, these are the returns of a portfolio of $1 million:
Most of us probably can’t live on $833 per month in retirement based on the worst case scenario. The weighted average case gives you a comfortable $113,000 per year. Remember, based on Lending Club’s claim that 100% of 800 note portfolios have a positive return, you do not have to worry about losing your principle. That makes this a very low risk investment.
To compare with the S&P 500, a standard measure for the overall market return, we have seen an average return of 6.58% (annualized 15 year return). It seems that p2p lending beats that hands down for nearly 90% of investors.
Lifestyle Goals
While a $1 million portfolio is a stretch for a lot of us, I did a little backwards math to find out what you would need to make $5,000 per month, or $60,000 per year, in cash flow.
To hit this cash flow level with our weighted average return, you only need $531,000 in your portfolio. That is much more achievable for the average investor than a seven digit portfolio. However, to be safe if you are in the bottom 1%, you would need a $6,000,000 portfolio.
Is This Safe For Your Retirement?
At this point, there is little data on the returns of seven digit portfolios on p2p lending platforms. It is hard to say how you would fare if you put your entire retirement on the line for unsecured borrowers at $25 increments. I would never put all of my eggs in one basket. While you can diversify within your Lending Club or Prosper portfolio, I would not put everything in other people’s hands.
However, based on what is available, it looks like p2p lending could become an important piece of the puzzle for people looking for a retirement income stream. Returns are solid, losses are minimal when you diversify, and you can certainly create a cash flow from your investment.
What Do You Think?
Is a p2p lending cash flow something you would want to use during retirement? Is it something you can use before retirement to supplement your income from your current savings? Are you already using this strategy? Please share your thoughts in the comments.
I’ve used it for a bit over 2 years. Pretty solid returns, but I urge everyone to check out lendstats.com for a not-so-rosey look at the actual returns that independent site shows. I own most of my loans through an IRA so no tax (the interest will be taxed as income, which could be a problem for high income earners).
“To compare with the S&P 500, a standard measure for the overall market return, we have seen an average return of 6.58% (annualized 15 year return)” Can you cite this source? This number varies so much depending on who you talk to. I believe your number also includes dividend income.
I use http://www.moneychimp.com/features/market_cagr.htm when comparing time periods of the market. Your number is pretty close though (6.72%).
@MZ, I am a huge fan of Lendstats.com and I highly recommend all p2p investors spend some time there or on Nickelsteamroller.com to do their own research. And yes, everyone should invest through an IRA if at all possible.
@Michael, I have pinged Eric to see if he can tell us the source of his numbers.
MZ – You make a good point on the taxes. I did not incorporate that into the equation. However, any investment will have taxes so that is still an apples to apples comparison to other investment options, though the effective cash flow would indeed be lower depending on your bracket.
Michael – I used the 15 year annualized return from the chart found here: http://en.wikipedia.org/wiki/S%26P_500
Can you clarify something? You’re saying that if I had $531,000, I could potentially (in a best-case scenario) make $60,000 a year by living on the interest and reinvesting the principle?
Eric,
I hope you see that as a theroretical example. While ROI on Lending Club might be good at the moment, I would not rely on p2p lending income as an (sole) retirement income source (regardless of platform). There are multiple risks that might endanger the outcome aside from borrowers not paying back. Think about: platform failing or high rise in inflation for example.
I would think it is good advise to only put a small portion of your assets in p2p lending.
1: LC states you should invest no more then 10% of your net worth.
2: A look at Lendingstats or Nicks site will show that 8% is more realistic then 11.3%
3: 8% is nothing to sneaze at, however it taxed at regular income rate. Dividens are taxed at prefered rate.
4: I would love it IF LC offered a Prime Account with an OPTION to automatically reinvest principle, while paying out interest monthly.
Simon – That is correct, assuming the best case scenario (which I would not do)
P2P-Banking – Yes, it is a theoretical example. I would never throw everything into one bucket. Diversity is key for a well rounded investment plan. I wrote this as a fun example of what may be possible.
Charlie – You make good points. It would be great to see LC or Prosper have an option to reinvest principle and get the cash flow back. Maybe they will read this and we will see it sometime soon!
@ Charlie – We at Prosper do read these forums and I have passed this suggestion on to our product development team. 🙂
By the way, since we can’t possibly read every forum if anyone ever has a suggestion, they are welcome to contact me at GMillar prosper and I’ll pass along the suggestion(s) to the right person.
Thanks,
Glenn G. Millar
Prosper Employee
Thanks Glenn
I would consider Lending Club a growth investment and not a retirement. It’s a fairly new investment tool, and we are going into an interesting economy. I wouldn’t consider Lending Club for more than 10% of my retirement money, let alone 10% of my net worth. We just need more data based on more economic cycles.
@Marc
You can make into what you want. The A/B grade loans will be like your Wal-mart or McDonald’s equities, way the way to G which would be like bio-pharma or a new tech company. Although you will never be able to do better than 25% on lending club because of what they cap interest rates at. This is the premium you pay for reduced volatility and more stable returns.
I believe A/B grade notes are well suited for retirement accounts and you are looking at about 5-6% for your return with those notes, maybe higher. In the last 10 years the symbol DIA has produced a TOTAL ROI of 15% (excluding dividends). If I was in retirement I would be looking at P2P very closely.
To your point though there isn’t much operational history. Lending club has been operational for 1621 days and has less than a 9% default rate on seasoned loans. This also includes the financial crisis. You should read the last two posts on my blog, they might help. Good luck.
Michael,
Thank you for your perspective. I’m an early adopter for my “play” money, but my retirement money I’d need more than 5 years of history. It’s not just the crises, but the good times. Will that dry up loans? I don’t think we’ve seen the bottom of our current situation. Will be have higher default rates? The only part of the economic cycle it’s really seen is a slight uptick from bad and then back into bad.
Now this is just my personal risk level. Right now I have most of my retirement in cash equivalents and it’s done quite well, compared to the rest of my portfolio. I will move out of cash equivalents when I feel we’re closer to the bottom of our economic situation. I agree with you that for many people, A/B grade notes would be a great retirement, I’m just not one of them.
As to “you will never be able to do better than 25%,” in the secondary market my median annualized return on notes sold is around 40% (take a look at my blog for details). While I’m not over the 25% overall, I don’t think it’s impossible to do better than 25%, it just hasn’t been done yet (to my knowledge). They also thought you couldn’t run faster then a 4-minute mile.
@Marc
Once I clicked your link above I knew you were going to refute my statement (I’ve read your blog in the past). Let’s just agree on that statement for the primary market.
I still don’t understand how you find people that will over pay for notes. Nonetheless it’s an interesting approach especially because you account for tax losses.
What cash equivalents are you utilizing right now? Just curious.
Michael,
I have no experience in primary market, I’ll leave all statements about that to those who have experience in it. (BTW, your blog is great! I updated my risk calculations based on some info in there.)
As far as my retirement account, I have few choices as it is an employers 401(k) that holds most of my retirement funds. Looking at it now, it looks like it is mainly 90 day T-Bill, Barclays Aggregate Bond, etc. I really don’t know much about the choices I have through my 401(k), but that is what seemed to meet what I feel would do the best through the next year.
@Marc
Likewise with your blog. I just put every note I have in grace on the secondary market. We’ll see how it goes!
You’re already digging into the numbers. I feel your confidence will rise with time. Maybe you will open an IRA with LC soon, who knows.
You might check out Prosper.com – they do not have any State restrictions to my knowledge. They also have a secondary market. I have a quite a few charts that compare the two platforms on my site. Prosper is doing very well.
@Michael, As for right now there are still state restrictions on Prosper for the secondary market. The eligible states for the primary and secondary markets are the same. Although I have been told that this is changing some time soon and more states will be open for secondary market participants.