I have been thinking lately that there are really two kinds of investing when it comes to peer to peer lending. When you transfer money in to Prosper or Lending Club you have a large amount of cash waiting to be invested. Then once this cash is invested you will get repayments coming in regularly that will slowly build your cash reserves for reinvesting.
This difference is highlighted when you put in a large amount of money, say $5,000 or more. Now, staying diversified (at the $25 minimum) this will mean you will invest in 200 notes or more. But once you are fully invested, an account of $5,000 will only generate $50 – $100 per month depending on the terms of the loans in the portfolio. So you go from investing in 200 notes in one hit to reinvesting in around 4 notes a month. Clearly a different approach is needed.
When Investing New Money in P2P Lending
With new cash in your account you have to balance putting your money to work quickly versus refining your filtering criteria. With my new Lending Club Roth IRA, I started investing back in May and I am only two-thirds of the way towards full investment. I have decided I would rather take additional time to invest in just the specific loans I want rather than investing my money quickly. This money for the Roth IRA came out of a money market account earning 0.08% so I feel that I am not missing out on much by investing slowly.
I wouldn’t recommend the way I invest to everybody. Many new investors may not have the patience to take this much time to invest. In fact, if you are a new investor you could easily use one of the investing tools on Prosper (Quick Invest) and Lending Club (Portfolio Builder) that allow you to invest your money quickly.
If you want to put your cash to work this way then I would just choose some loan grades, depending on your tolerance for defaults, add the filter inquiries=0 (my favorite filter) and invest. Most new investors are excited to get started and with this approach you may well be able to put all your cash to work in one day.
For example, of the 785 loans on Lending Club at the time of this writing around half had zero inquiries. A similar proportion is available on Prosper. If you choose a couple of loan grades you can put your money to work right away and be fully invested in just a few clicks of your mouse.
Reinvesting Your Cash
Once you have all your cash invested in notes you can afford to be much pickier with your investments. This is when I recommend you spend several of hours on Lendstats familiarizing yourself with the various filters and their resulting estimated ROI. Then you can decide exactly which filters you want to apply to your reinvestments.
When you filter down the available loans with your new criteria you may well find more loans available than funds. In this case I would still stick with your $25 minimum investment (unless you already have more than 500 notes) and do one of two things. Refine your filtering criteria further or just read through the loans and eliminate some loans based on loan descriptions or questions and answers.
Of course, if you have a great deal of patience then I always recommend doing extensive research and understanding how to generate the best returns on your money. If you are happy to invest slowly you could take the approach that I do and be very selective on which loans to invest in from the start. You will likely end up with a higher ROI by doing this. And it will also mean you have a consistent portfolio of loans.
How have others done it? Did you invest your initial cash quickly or slowly? As always, I am interested to hear your comments.
I was recently able to find quite a good number of notes on the trading platform, with buying existing notes you can become fully invested much faster, and even get them at a discount occationally. The downside is that the filter cababilties on the trading platform are very limited and you must check each note manualy, but if you have the time and know how to search you could find plenty of good notes there.
@Moe, I didn’t discuss the trading platform here because of the downside you mentioned. I invest in only about 2-3% of notes on the platform (I have about 9-10 criteria), so it would take me forever to find notes I like on the trading platform with the filtering the way it is now. But for people with patience or for those with wider filters then it can certainly be a good place to get your money to work more quickly.
Peter………..If you really believe that a 500 sized portfolio will protect you from bad choices & deliver you a average return (as you stated last week), then what advantage is there to deploying money slowly with carefully selected filters etc. ? To improve on average perhaps?
Because you do realize that if 500 really is a number that is large enough to inoculate you from bad results & give you an average return……………..then that same 500 number is also large enough to make it EXTREMELY difficult if not impossible for you to outperform those same “average” returns. So what’s the extra time & effort for?
@Dan, First let me say that I do believe a 500-note portfolio will help protect you against a negative return, which was the subject of my previous post. But I completely disagree that the same 500 number makes it “EXTREMELY difficult if not impossible for you to outperform those same ‘average’ returns” as you claim.
This is why. Between Lending Club and Prosper they are funding well over 2,500 a month. If you are want to take two or three months to create a 500-note portfolio then you will have the choice of around 5,000 notes on Lending Club or 2,800 notes on Prosper. With careful note picking it doesn’t seem much of a stretch that you could outperform the average given that you are trying to pick the best 10-20% of notes on the platform.
Having said that, I will concede that if you create a 500-note portfolio in one day, with around 600-700 notes (roughly) on each platform at any one time it will be very difficult to achieve anything other than an average return.
500 notes “average” return
I think it depends on how you define average. Setting aside the issue of how you calculate your return….
Are we defining average as 9.6%?
Are we defining average as the average based on the grade of note selected?
Are we defining average as the average based on the lendingstats prediction of ROI?
For a large portfolio ($12,500 500 notes) with an average loan age of over 18months it is going to be hard to beat 9.6%. Especially since that 9.6% is calculated based on average younger loan age due to LendingClubs accelerating loan volume.
Lending Stats reports a ROI of 4.83% for all Lending Club loans. Average loan age of 11 month. I think it is possible to beat this through selective loan filters.
“then what advantage is there to deploying money slowly with carefully selected filters etc. ? To improve on average perhaps?”
I suppose everyone who follows this method has his/her own answer, but mine is: 1) it’s FUN – why get in a huge rush? ….and 2) I am still learning.
When I first started with LC, I purchased a couple of “nightmare” notes on the Trading Platform that were bad purchases in every possible respect. THAT was an expensive lesson that may take me some time to recover from in terms of amount lost. But you can be darn sure I won’t make that same mistake again. And fortunately, it wasn’t money that I couldn’t afford to lose. I just didn’t want to lose it.
That reminds me. I think I’ll go reprice those notes and see if I can’t get something out of them.
I don’t have much of a choice but to invest a bit slower. While I invest larger amounts per loan, there are still only a few loans per week that meet my criteria.
Jason
Peter………..I never said a 500 note portfolio wouldn’t protect you against a NEGATIVE return. It certainly should. And so should a 100 sized portfolio. So what?
But here’s something to keep in mind. Even using Lending Club’s liberal interpretation of returns & even at 800 notes, there is still a 9% of investors (or 1 in 11) end up doing AT LEAST 3.6% BELOW what they call their “average” of 9.6%. So clearly 800 wasn’t large enough to protect these guys. So you think 500 is adequate protection?
@Charlie, I define average as somewhere around 10% as stated by Lending Club and Prosper that equates to a real world return of somewhere around 8-9%. I realize that return is based on loans that have a relatively young average age and if one stops reinvesting I concede it will be more difficult to beat that average.
But I believe it is possible with even a large portfolio of 500 notes that you can beat the average and that is one of my goals of this blog. It is to explore what works and help savvy investors beat the average. Otherwise you could just use the automated tools and forget about it.
@gharkness, I think we are all still learning here, I know I am. We make mistakes and learn from them so we can not only avoid losses but make good decisions and create an above average portfolio. I agree there is no rush, but many investors see a possible 10% return and are in a hurry to make it happen. I was a bit that way myself two years ago when I started investing.
@Bilgefisher, So my question for you is, did you start out investing slowly or is this something you have adopted once you have learned more about p2p lending?
@Dan, Keep in mind we are talking about 9% of investors with at least 800 notes. Now, I have no idea on the numbers but based on Prosper’s experience (for Prosper 2.0) around 1% of investors have 800 or more notes. So, if that same ratio holds for Lending Club (and they claim around 26,000 active investors) then we are talking around 260 investors, which means something like 24 investors are achieving returns of between 0 and 6%. Who knows what mistakes this tiny number of investors have made but I would hazard a guess that they have made some.
@Peter…………Agh, but didn’t you say that having a 500+ portfolio protects you regardless of the choices you make in setting filters &/or picking notes??
In fact I quote…………….”if you have 500 notes it doesn’t matter what criteria you use you will likely generate a positive ROI. You have the law of large numbers working for you – this negates the impact of bad luck and bad choices.”
So it shouldn’t have mattered if this group made mistakes or not……………..according to your theory. And incidentally, once you bring the portfolio size down to 400+, the under performing numbers rise to 12% or so. That’s almost 1 of 8.
All I’m saying is that considering that your chances of underperforming at 400+ notes is a very substantial 12% & underperforming at 800+ a not inconsequential 9%, it might be wise not to make any grand statements about 500 being some magical number that renders one immune from substandard or downright bad returns.
@Dan, I think we talking about slightly different things here. Yes, I did say that 500 notes will likely generate a positive ROI but I never said it would likely give you an above average ROI or even prevent you from underperforming. You may well generate a below average ROI with 500 notes as you rightly point out, my point is that such a widely diversified portfolio will likely protect you from a negative ROI.
Also, since you are focusing on the 9% of under performers at 800+ notes, I feel compelled to point out that at the opposite end of the spectrum is the 15% of investors who are earning above 12%. At the 400 note level that number increases to 17% of investors earning about 12%. Just thought I would point that out.
Peter………….But that 15% earning 12%+ is mainly composed of young to very young lenders whose returns have yet to be hit by defaults many defaults etc In other words, we don’t know where their numbers are going to end up yet……………..whereas the 9% that I pointed out are likely to be much older lenders who have already taken their hits…………..as evidenced by their weak numbers.
In other words, it’s likely that some, maybe many, of the 12% performers will see their numbers decline as time goes by…………….but it’s unlikely that a substantial amount of the underperformers will recover to postt even average returns.
@Dan, Quite likely you are right – these are probably newer portfolios. It would be nice if Lending Club gave us some idea of portfolio age when they put these charts together.
I would be happly suprised at a 9% ROI on a portfolio that has an average age of 18 month +
Lending Stats reports a ROI of 3.83% for all completed 36 month loans average age 36 months with a default rate of 16%. This I think is beatable.
Lending Stats reports a ROI of 4.83% for all Lending Club loans average age 11 months. This I think is beatable.
Using the Zero Inquiries filter on all loans gives an ROI of 8.95% with an average age of 9.7 months and a default rate of 1.5%
Changing the loan cut off to Aug-2010 drops the ROI to 8.47% with an average age of 16.7 months with a 3.6% default rate.
Changing the loan cut off to Aug-2009 drops the ROI to 7.28%% with an average age of 27.5 months with a 8.7% default rate.
IMHO an actual real return of 6-9% is realistic.
@Charlie, You make some valid points. For most investors a real world return of 6-9% is realistic with Lending Club in the long run. But I intend to be above average and my goal with this blog is to show other investors to be the same. I believe that 12-13% is achievable as a long term real world return but you need to choose your portfolio carefully for this to be a possibility.
I think Charlie makes some “realistic” points. The 36 month completed & the 11 month old ROI numbers are very beatable.
On the other hand, Peter, most investors should be ecstatic with a 9% long term return.
Your 12-13% target? Short term? Absolutely, it’s been done by almost everybody with the risk tolerance…………… within their early months of investing.
Long term? Unlikely…………..Long term with 500+ notes? Even more unlikely…………..Long term with 2000 notes? Virtually impossible. Make me a liar!
@Dan, I think we are going to have to agree to disagree….at least for now. This is the way I look at it – there are around 25,000 loans outstanding on Lending Club right now and they are adding around 2,000 loans a month (and obviously that number is growing). This leaves a lot of room to pick the 500 best loans – particularly if you invest new money over a 2-3 month period. Even if you just eliminate most of the bottom half of performing loans (by investing mainly in the higher interest rate loans) I can see a 500 note portfolio performing at 12-13% annually. If you invest slowly (over 4-6 months) I could even see a 2,000 note portfolio performing at that level.
As for Prosper, there are fewer notes – you only have around 18,000 loans with approximately 1,000 being added a month. But Prosper offers investors higher interest rates so I think, frankly, it will be relatively easy to earn 12-13% on Prosper long term. I am actually shooting for a couple of percentage points higher than that.
I will be reporting my own progress here as a test case but I am sure there will be plenty of investors who will achieve higher long term returns than I do.
Peter………….Your 12-13% calculations are based almost entirely on the assumptions that you can consistently pick out the best borrowers today & project the lives & circumstances of these people for the next 3-5 years. And since none of us have a crystal ball, you’re making these determinations based on historical information from past borrowers with similar circumstances, credit scores, histories, etc etc. And I understand that you’ve played around with the numbers & have a set of parameters that have delivered the best returns in the past. All sounds very scientific & appealing.
The problem I see is that to hit 12-13% long term you’d have to hit the mark on pretty much all the filters you’ve picked out. Again it sounds very doable……….until one considers that you don’t really know that the filters will continue to outperform as they have in the past…………..simply because, in most cases, you don’t know why they’ve done well to begin with. You can only hypothesize. And to make matters even more precarious, the historical data available is still very limited. I mean you’re making some decisions with sample sizes of a couple of hundred. No offence, but that’s a bit of a joke.
Please understand that I’m not doubting your ability to get better than average returns. I’m doubting your ability to get MUCH better than average returns & with with a large number of notes no less.
@Dan, I am aware of all your concerns here – they concern me as well – and I am confident that the numbers I state can be achieved. Am I being naive and overly optimistic? Maybe. Only time will tell. But I am sure going to shoot for 12-13% and will report back here on my progress.
In statistics, a spurious relationship (or, sometimes, spurious correlation or spurious regression) is a mathematical relationship in which two events or variables have no direct causal connection, yet it may be wrongly inferred that they do, due to either coincidence or the presence of a certain third, unseen factor.
Why do I mention this. Digging through the LendingStats data I have found many of these. This is normally due to the fact that when you start filtering the data you start to deal with a tiny number of loans (<200). When you dealing with small numbers, random chance can cause spurious relationship.
This will lead to filters that show high ROI because of RANDOM chance not because of the inherent likely hood of future borrowers meeting the same criteria will also perform.
This is why we need to do some REAL anaylsis of the data.
@Charlie, Yes I realize that there may be some serious flaws in my statistical analysis of the Lendstats data. As I have said many time I am no expert in this field. So, we keep mentioning the need to do some REAL analysis of this data, as you suggest, but I have not heard from any volunteers. I would love to hear from someone who really knows this stuff. Feel free to reach out to me off line via the Contact form on this site.
@Peter
This P2P is a brave new world for indivdual investors. Check your inbox. 🙂
@Charlie, Are you talking about the email from Prosper? I just read it and they certainly put forward some compelling numbers. Although we have seen these numbers before on their blog and in press releases.