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%.
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: [Read more…]