Portfolio Update and Four More Thoughts on Prime Consumer Notes

This is the second guest post from long time reader, Josh Brooks. His first post was one year ago and here he provides an update on his Lending Club portfolios as well as some more discussion points.

One year ago, Peter was nice enough to let me submit a guest post titled Four Thoughts on Consumer Debt Notes.  That post generated a lot of good discussion and debate from Lend Academy readers.  One point offered was that the rates of return I presented were characteristic of young portfolios, and were not sustainable.  It was suggested that I provide an update in one year, so here it is.

Portfolio Update

We (my wife and I) still have three Lending Club accounts (that I manage):  one regular account, her Roth IRA, and my Roth IRA.

Note:  Lending Club’s Net Annualized Return (NAR) calculation accurately reflects my own internal Rate of Return (RoR) calculations, and is therefore, I think, an accurate metric for measuring investment effectiveness for the purposes of this post.

LC NAR Oct 2012LC NAR Oct 2013Account AgeAverage Note Age
Regular Account16.3%15.6%32 mths12.9 mths
Wife's IRA 18.5%17.8%21 mths8.0 mths
Josh's IRA17.7%16.5%27 mths12.2 mths

As you can see, the NAR decayed over the last year by 0.7%, 0.7%, and 1.2% respectively, but remains above 15% in all three accounts.  This decay in NAR is in all likelihood the result of an increase in the total number of defaulted notes in the portfolio (as the portfolio ages, the total number of defaulted notes will increase, even if the default rate remains the same).  Also, using the portfolio analysis tool at Nickel Steamroller, we can see that my three portfolios are still young, so further NAR decay can be expected.  However, assuming a NAR decay of 1.0% per year, I still believe that a long-term, stabilized NAR of 13.0% or 13.5% is possible.

Four More Thoughts on Prime Consumer Notes

In addition to an update on my portfolio, I wanted to also offer the following thoughts, for readers’ consideration:

1.  I have stopped selling very late notes on the secondary market as a way to mitigate losses from defaults.  I made this change for at least two reasons.  First, it is labor intensive to identify, list, price, and track defaulting notes, and it essentially makes investing in prime consumer notes through Lending Club an active (not passive) investment activity.  Further on this point, there is nothing more frustrating than listing a very late note at a deep discount, having it come current, and then having that now current note sell for a fraction of its value.

Second, forcing myself to spend twenty or thirty minutes every other day or so focusing on all of my defaulting notes was having an adverse effect on my perception of prime consumer note investing.  Instead of dwelling on the negative, I would prefer instead to focus on the positive by watching my account value grow and calculating my RoR.

I know it sounds simple, but if I enjoy something, I will continue to do it.  In contrast, if I dread logging into Lending Club because I make myself wade through all of my defaulting notes every other day, I am likely to delay, defer, and neglect my Lending Club investing activity.

2.  I credit what success I am having with investing in Lending Club prime consumer notes to my development of a good filter.  If you don’t have a good filter that is effective in screening out those notes most likely to default, I would strongly encourage you to develop, borrow, or buy one.  I used the CSV data file published by Lending Club to develop mine, and credit it for my high NAR and relatively low default rate.

3.  Similarly, to get the best notes, I am logging four times each day, to get a shot at notes as soon as they are listed.  It is amazing to see a $35,000 loan get fully funded in less than one minute.  If the big money is that confident in that loan (because they have a good filter, and that loan meets the statistically-supported criteria of that filter), I want to get my $25 of action as well.  To do that, I have to be there to buy as soon as they are listed.

4.  While I am certainly not a tax expert or an economist, I have found that the post-tax, post-inflation RoR is one helpful way to conceptualize Lending Club prime consumer notes as a perpetual INCOME STREAM investment.  For example, assuming that you can earn a 13% Lending Club NAR, are in the 28% income tax bracket, and have 3.5% inflation, you could realize a 5.86% RoR (post-tax, post-inflation) perpetual INCOME STREAM:

13% LC NAR  –  28% Income Tax  –  3.5% Inflation  =  5.86% Perpetual INCOME STREAM

[Editor’s note: a 13% real world return is an aggressive goal and may only be achievable long term to the very top investors.]

In this example, a Lending Club prime consumer notes portfolio could throw off 5.86% of usable income, after taxes are paid, after 3.5% of the interest is re-invested to grow the account to adjust for inflation.  And because the account would be growing to keep up with inflation, no loss of purchasing power would occur (which is a common risk when investing in debt).  Finally, since the principal is not getting touched (but is in fact being grown to keep up with inflation), this portfolio becomes a perpetual source of income.


In summary, I still find great value in investing in Lending Club prime consumer notes.  It is still my highest yielding semi-passive investment, in addition to having very low volatility and very high diversification ($25 notes per loan spread out over hundreds/thousands of loans).

Thanks to Peter for letting me post again.  If it pleases Peter and the group, I will be back in October 2014 with another update.  Until then, please share your comments below or if you have a specific question you can email me directly at 24jbrooks@gmail.com.  Thank you.

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Dan B
Dan B
Oct. 22, 2013 1:59 pm

Quote from last year “I have been able to enjoy net annualized returns that are currently more than 16.30%, 17.70%, and 18.50%. It is important to note that my accounts are still young (9, 15, and 20 months old), but so far, by employing this risk management, the net annualized return I enjoy is increasing (as a result of picking better, higher rate notes), instead of decreasing (as a result of defaulting notes eating into my rate of return).”

The above quote by Josh was taken from his article last year & generated a good deal of controversy including a great deal of criticism from myself & from Roy S as we claimed that his returns were unsustainable & unrealistic going forward. We also stated that his claims suggesting that his returns were actually INCREASING over time was irresponsible, unreasonable, unrealistic, ridiculous or some words to that effect. As you can see our criticisms have now been proven CORRECT.

Nevertheless I would like to commend Josh for having the courage to come here & provide this update despite the fact that his claims of higher returns going forward have proven to be WRONG. Of course, pls. correct me if I missed it but I don’t see any admission that he was in fact wrong last year…………..nor do I see anything saying Dan B & Roy S. were correct.

At the time, last October, when Josh’s post was published, Peter came out & stated & I quote …..” Here is my opinion. These returns are indeed possible by any investor in Lending Club. Are his returns likely to remain this high going forward? No. Is it possible? Yes.”

I think we can all see the value of that particular nugget of wisdom without me spelling it out. I would also encourage all new readers & readers unfamiliar to the post last year to go back & read it & the comments that were posted & judge for themselves whether it was appropriate for me to STRONGLY caution new investors that Josh’s claims of high return numbers & increasing return numbers from the already high levels he claimed were in fact appropriate or not.

Readers may also want to consider why Peter came down on me so harshly when I suggested that he was doing a disservice to new investors by suggesting that the article provided advice that numbers in the high teens & above were attainable by new investors………..& by him publishing & agreeing with it, only to back pedal away after withering criticism.
Readers can decide for themselves who was really trying to protect their interests from unrealistic expectations & who was just blindly waving the p2p flag like a cheerleader..

Dan B
Dan B
Oct. 22, 2013 4:13 pm
Reply to  Peter Renton

I have some comments about this article & I will share them when the author & the publisher of last years piece admit that they were wrong & that myself & Roy S. et al were correct & justified in the admittedly aggressive comments that we made back then. Comments that have been shown to be pretty accurate since then & will continue to be accurate going forward.

People talk a lot of crap on the internet & need to be held minimally accountable imo. Once proper acknowledgement is received, I will graciously accept & move on. Until then I see no reason to just disregard all the irrational exuberance & general rubbish that was spewed back then.

Josh Brooks
Josh Brooks
Oct. 22, 2013 7:34 pm
Reply to  Dan B

Dan B, Peter, et al.,

1. Obviously, I knew that by providing this update I would have to account for my statements in last year’s post (and more specifically, possibly be the subject of Dan B and Roy S’s attention again), and that’s OK; I wanted to do this. Dan B makes a good point, in my opinion, about accountability. I want to be accountable for my actions and statements, so here I am.

2. To Dan B: while some of your tone and language can be off-putting and detracts from your message, your input last year and this year are valid, I think. To be clear: I acknowledge that my naivety with this new and emerging asset class, combined with my over-optimism resulted in my over-estimating the sustainable long-term returns that are probably possible with LC prime consumer notes. The estimate that I offered last year is not accurate; I no longer believe that >15% NAR is sustainable over the long-term. My best estimate of the situation now is that (with a good filter and picking the right notes) you start off in your first year with about 18% or 18.5% NAR, then experience a NAR decay of about 1% per year (for five years), to arrive at a sustainable long-term yield of 13% or 13.5%.

3. In concert with Dan B’s protest: buyer beware. If you use a filter like the one that I use, and invest in LC prime consumer notes the way that I do, you may only realize 13% or 13.5% NAR, not >15% NAR :-). In all seriousness, it is important that individuals do their own proper due diligence when making investment decisions. If you decide to consider my thoughts, please do so as one small piece of a bigger mosaic of knowledge.

Thanks again to Peter for letting me post. Thanks to Dan B for his feedback. Thanks to everyone who took the time to read my guest post. Thanks to Lending Club for the killer returns.

Dan B
Dan B
Oct. 22, 2013 8:04 pm
Reply to  Josh Brooks

Thank you Josh for that acknowledgement. Although your article was the focus of my remarks, I want you to know that most of what I said last year was directed at Peter, not you. You were pretty new to the game last year, Peter wasn’t & should have known better.

Regardless, like I said previously, I commend you for coming back here & exposing yourself to criticism. In the almost 4 years that I’ve been commenting on various blogs I’ve run into few who were willing to do what you’ve done. Most just fade away quietly.

I sincerely congratulate you on a very successful first year. Though I suspect that you will find it very hard to achieve that 13-13.5% you’re aiming for long term, I have no doubt whatsoever that you will continue to outperform the average LC investor’s return. I also believe that your mindset on all this is now in a much more realistic place. I look forward to hearing from you again next year.

Best wishes,
Dan B.

Bo Brustkern
Bo Brustkern
Oct. 22, 2013 3:54 pm

Congratulations, Josh, on such healthy returns. Well done, and I look forward to your next update.

Dan B: I’m not sure where you’re coming from, or why you’re resorting to the ALL CAPS maneuver here. Please be civilized, stop shouting at us, and applaud Mr. Brooks for crushing it.

Dan B
Dan B
Oct. 22, 2013 4:17 pm
Reply to  Bo Brustkern

I’m sorry, who are you again? Did you just take ownership of this site? Using a few CAPS in a multi-paragraph response is hardly over the top imo…………especially when it is done to highlight. And thank you for the advice. I will be sure to give it the proper consideration that it & you deserve. 🙂

Josh Brooks
Josh Brooks
Oct. 22, 2013 7:36 pm
Reply to  Bo Brustkern

Thanks for reading, Bo. I’ll be back in October 2014, if it suits Peter and the group.

Rob L
Rob L
Oct. 23, 2013 3:59 am

Thank you for the interesting article. I look forward to continuing future updates. My original intent was to be a passive buy and hold investor, but early on I did did sell a few notes on the secondary market that were going past due. The fact that my decisions were seat of the pants with no backtested selection method made me question whether or not it was helping, hurting or tossing a coin. This combined with the time consuming nature of the activity led me to fugeddaboudit and stick with the passive only approach. With the notification now on the LC web site that, for the time, investors with IRA accounts cannot use the secondary market makes it a moot point for me anyway.
I look at my LC account summary page at least once a day, so I’m an actively interested passive investor. To give me a more realistic, even pessimistic picture, I mentally ignore notes in grace period, add up the value of all notes 30+ days late and subtract them from my account total as if they all defaulted. Finally I make a NAR guestimate, (way less than the number on the screen), compare it with my risk/reward valuations of other investments, and at least so far I think gee, this is going great. Maybe my expectations are too low, but I prefer pleasant surprises.

Josh Brooks
Josh Brooks
Oct. 23, 2013 3:36 pm
Reply to  Rob L

Rob L.,

You make a good point, I think, comparing LC prime consumer notes to other investments. The effects of taxation and inflation are different for different types of investments (e.g. prime consumer notes vs. municipal bond etf vs. covered calls vs. high-yield dividend etf), and can obviously have a profound effect on your post-tax, post-inflation return (which is my evaluation metric of choice).

Andrew N
Andrew N
Oct. 23, 2013 9:45 am

I don’t know why, but it bugs me when inflation is mentioned in articles like this. I don’t know what inflation is going to be going forward, but if you’re maximizing your nominal returns then by definition you’ll be maximizing your real returns.

B. Mason
Oct. 23, 2013 11:45 pm

Would you be willing to post your average interest rate for the portfolios? It’s available in the portfolio section of the website. I’m trying to get a sense of your exposure to 5-year loans.

Josh Brooks
Josh Brooks
Oct. 24, 2013 5:53 am
Reply to  B. Mason

B. Mason,

Regular Account 20.69% average rate, 99.7% 60 month loans
Wife’s RIRA 21.36% average rate, 100% 60 month loans
My RIRA 21.67% average rate, 99.7% 60 month loans

Hope this helps.

Bryce M.
Oct. 24, 2013 10:14 am
Reply to  Josh Brooks

Sure does! I’m eager now to incorporate 60-month loans to my modeling. Just a little more time…

New Jersey Guy
New Jersey Guy
Oct. 27, 2013 10:50 am

Josh….I’ve always thought it foolish to hold a note into default when the opportunity is there to get rid of it before hand.

However, you’re statement on being an active (like myself) trader or a passive (like yourself) trader shows the different styles of trading available to anybody. You were right in your statement that somebody shouldn’t dread logging into their account just to wade through late notes. Me, personally? I don’t mind it. But obviously, I put more time in as a result. But your results show that any investor can take your approach and get good returns by letting nature take it’s course.

The nice thing about P2P lending is that it’s not written in concrete and investors can pursue any type of return they want.

Josh Brooks
Josh Brooks
Oct. 28, 2013 3:28 pm
Reply to  New Jersey Guy

Good points, Jersey. I agree with you that the ink in the rule book of P2P investing has yet to dry.

Nov. 4, 2013 3:25 pm

Your comment about not selling notes because you don’t like seeing a deeply discounted note sell after going current. This should not happen. I thought I saw it happening too but after careful checking it does not happen. What did happen was

1) A note is late so I list it at a discount
2) The note becomes current because of a payment
3) The note is suddenly very attractive and “sells” very quickly.
4) I panic because I think I just sold a current note at a discount
…. wait a day or two
5) Sale gets cancelled because of the payment