What Percentage of Your Investments Should be in P2P Lending?

Even though I am very passionate about peer to peer lending I never recommend people invest all their money with Prosper or Lending Club. Peer to peer lending should be part of an overall investment strategy that covers a range of asset classes.

What is an Asset Class?

Before I go any further we need to have a basic understanding of asset classes. An asset class is like an investment category – for example the equities that make up the stock market are an asset class. Bonds are another asset class. Cash and cash equivalents (CD’s, money market funds, savings accounts, etc) are another. You could consider real estate another as well as commodities such as gold and oil.

Where Does Peer to Peer Lending Fit?

Peer to peer lending doesn’t fit easily into any asset class – it would be what many investment advisors call an “alternative investment”. It is thrown in with more exotic investments such as futures, currencies, private equity and venture capital. Many of these investments are very high risk, often require a large minimum investment and are subject to wild fluctuations in value. These are not true of peer to peer lending but this is where most people lump it.

Anyway, let’s get back to the original question here. Now, keep in mind I am not a qualified investment advisor, rather I am a self-taught investor with some strong opinions on the subject.

I am not going to get into a discussion here about what percentages of stocks versus bonds an investor should hold. I believe most investors should hold both and in what percentages is a judgment call. Every investor should also have an emergency cash fund in a money market or savings account that you can draw upon for unforeseen expenses.

No More Than 10% of Your Total Liquid Investments

I recommend all investors have no more than 10% of their total liquid investments in p2p lending. Also before they invest a penny they should make sure they understand how investing in Lending Club and Prosper works and the risks involved. The biggest risk is a lack of diversification, this is the one thing that can have a big negative impact on an investment.

Personally, I subscribe to this philosophy. Even though I truly believe in the future of p2p lending, with a mortgage and a family to support I don’t want to be more aggressive than this 10% number. If was young and single I might be tempted to invest 20% or possibly even more but a young person has time on their side.

Why Not More?

Peer to peer lending is not without risks. Just read through the prospectus of Lending Club and Prosper and you will see the risks described in great detail. Putting aside the risk of losing your money to defaulting borrowers there are other risks. This is still a young industry and there is always the possibility that it could be legislated out of existence (not likely but possible).

Five years ago no one would have thought Fortune 500 giants like General Motors or Washington Mutual would go bankrupt. But it happened. Now, both Prosper and Lending Club have contingency plans in place to protect investors should that happen to one of them, but the reality is we don’t know if these plans will work perfectly or not. So there is risk.

Having said that I think the rewards far outweigh the risks but not so much that I would want to put my entire nest egg in p2p lending. I will stick with my 10% maximum and recommend it to others as well. But I am willing to concede that it is a personal preference and others may feel differently.

What do you think? Is 10% not enough or too much? I am interested to hear your comments.

 

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Jim
Jim
Jul. 20, 2011 11:31 am

I think it would be hard to put a % on what to invest. As an example I have a retirement portfolio of several million dollars. I invest with Lending Club, but would not feel comfortable with several hundred thousand dollars tied up. I have a wide range of investments. I think each person has to decide how much their willing to invest in each vehicle used for investments. Lending Club is just one I choose to play around with a relatively small amount of money. Of course this is just my opinion.

CA-Lender
CA-Lender
Jul. 20, 2011 12:08 pm

Peter,

Excellent article. Almost as though you read my mind, as I was going to email you and ask your opinion on putting 33% of my liquid assets (10% of total assets, including real estate) in Prosper. I’m 43, and I think 10% might be a bit on the low side, but reading your article, I know that 33% is definitely too much.

c
c
May. 2, 2016 6:24 pm
Reply to  CA-Lender

I would n,t put a penny in unsecured debt. Why bother when there are assert backed alternatives

Bilgefisher
Jul. 20, 2011 2:34 pm

Peter,

10% probably works fantastic nicely for you. Others should look at their end goal, time frame to reach that goal, and risk tolerance. That will determine how much they should invest in high risk investments.

I’m not above 10%, but I would have no issue doing so based on my objectives.

Btw, I don’t disagree with your article. For most people, playing it safe is a much smarter way to go. 10% is a good rule of thumb. For the more proactive investors, they already have a good idea where they need to be.

Jason

Michael
Jul. 20, 2011 3:01 pm

@Jim.

I thought about the liquidity issue a lot. This is the conclusion I came to:

How liquid is a stock portfolio is that down 50%? Sure you can sell it… Expect your diet to consist mostly of bourbon for the rest of your life.

Say the same drop that happened in 2008 happened next year, would you rather be in stocks or Lending Club in terms of having to get your cash? You can liquidate in a matter of days for 1% on Foliofn (I think the 1% is crazy high by the way and hope it comes down in the future. 1% is just an insane spread).

I guess what I am saying is for me capital preservation key component in liquidity. If I was going to take a huge hit I would consider the stock market illiquid.


I’ve seen the number 10% used by others too. I think it makes sense given the limited history we have of notes. I personally will hover around 10%.

Michael
Jul. 20, 2011 3:45 pm


I actually feel the stock market crash would have little impact, it might even drive it up (demand on folio). People like to move into fixed income when the equity markets get spooked. The real threat is interest rates.

If the fed raises rates from whatever they are now, 0.0000001% we could see a point in the future where MMAs are offering 4% again which is about as “safe” as you can get. Grade A (~5.5% return) notes will have a hard time trying compete with something as simple as a MMA. LC will have to raise A grade loans to something like 6%. That is where your biggest discounts will happen. Interest rates can only go up from here!

Of course a run on notes is a possibility. If LC tomorrow filed for bankruptcy (unlikely due to the fact they are positive cash now) there would be a rush to the secondary markets with basically no one to buy. Your notes would end up in court.

Michael
Jul. 20, 2011 4:28 pm

To put it in perspective:

With a loan for $100K at 5% over 30 years you will pay $193,255 total in debt repayment.

If I invest $100K a mutual fund, it needs to earn 2.2% a year to be $193,255 in 30 years. So in essence the banks rate of return on your mortgage is 2.2% before inflation at this point in time.

Inflation is 3-4% historically on average per year which means every mortgage made in the last 3 years is a loss for the bank over the life of the loan. You get get a 15 year fixed right now for 3.5%. All the banks are doing is making money on fees at this point. Interest rates need to come up, and a lot!

The biggest ally the p2p industry has now and for the foreseeable future is the credit card industry. It’s really not hard to compete with 20+% finance charges. As long as they (p2p) can provide rates lower than them (cc), they will always have business. All you need is the government to say credit card rates can’t exceed 10% then you will really see a notes on folio. 🙂

Brian B
Brian B
Jul. 20, 2011 7:35 pm

It should be noted that anyone that purchases notes in excess of 10% of their networth is in violation of Lending Club’s Investor Agreement. That was one of those checkboxes you had to check and say you read and agreed to when you created your account. So if you do want to invest more than this in p2p lending, you will need to spread the amounts over multiple sites (or possibly invest only only Prosper, I’m not sure what their financial suitability requirements are).

They probably would never find out if you go over this amount. And even if they did, they might not do anything. But you’d certainly risk having them close your account or take other actions, so its something to at least be aware of.

Exact Text:
“regardless of your state of residence, you agree that you will not purchase Notes in an amount in excess of 10% of your net worth, determined exclusive of the value of your home, home furnishings and automobile.”
https://www.lendingclub.com/info/lender-agreement.action

Jason Greschler
Jason Greschler
Jul. 2, 2014 1:11 pm
Reply to  Peter Renton

I feel I should mention that Prosper also has the same restriction on investing when it comes to the 10%. Also, in California there are additional restrictions, such as you must be making at least 85k per year, and have a reasonable expectation that you will continue to do so, and you can only invest 10% of your net worth. If you don’t meet the criteria for California, you can only invest up to $2500. I wrote to Lending Club about this and they said it had to do with state law (although I suspect the 10% requirement is federal law, or SEC rules, google financial suitability, because it seems to apply to all states). I don’t know how they go about policing this. I suppose you could get away with 10% of your net worth in Lending Club and 10% of your net worth in Prosper. Who determines your net worth by the way ? If I have a Picasso painting on my wall, does that contribute to my net worth ? How much ? Is it subjective ?

ChasingBread
ChasingBread
Jul. 21, 2011 11:19 am

Scared money doesn’t make money (jk but the saying is a bit funny and true) .

Invest what you can afford to lose into P2P. I have invested solely into Prosper and made $20k in interest in a year. Of course, I have not recouped my initial investment but things are looking good. This month will be 15 months of enjoying the risk of P2P.

10% is a very good number for people with more financial responsibilities than me. I have 0 debt; therefore, I can afford to play big like this.

CA-Lender, I say go for it if you have the money to risk. Peter gives great advice on here. Diversify, but not to the point where you don’t have time to study each and every loan you invest in. Thats my motto. I can low enough where I have time to study each and every loan I invest in. I do not use quick invest nor did I use the automated plans.

Charlie H
Charlie H
Jul. 21, 2011 6:51 pm

“10% of Your Total Liquid Investments”

The only truely Liquid Investments is cash and short duration T-bills. Sure you can liquidate a mutal or bund fund at any time, but the question is at what price.

You can liquidate your house tomorrow if you wanted to sell it for 50% bellow par. Is a home a liquid assest?

IMHO Lending Club should be looked at as the JUNK bond / high yield portion of your bond portfolio. It has the same interest rate risks after all.

If you are 70% equities, 20% bonds and 10% cash then lending club should be a portion of the 20% part of the bond fund.
The 10% cash is there so you do not have to sell durring pull backs if you need extra liqudity.

With that in mind the 10% limit LC places on total net worth is more then adaquate.

ChasingBread
ChasingBread
Jul. 21, 2011 9:09 pm

, you are absolutely right. I should have expressed that better; it is a personal choice. I diversify a bit but not as much as others. I like to diversify to the point where I have enough time to look at each one and ask questions if i have any.

Depending on the loan you may not have enough time to ask questions. Worth-blanket2 has been funding good loans completely or at least most of it on Prosper.

He is leaving the little guys like us out but on a flip note, if you do get some money in at least it will process quicker and become a note faster.

Bilgefisher
Jul. 22, 2011 7:27 am

All valid points here. 10% is net worth. I’m only playing with liquid investing reserves. Much of my net worth is far from liquid. That’s were my risk tolerance hits its boundary.

Peter, you mentioned you have a system yo look through many notes and invest in under 15 minutes. I think any one who doesn’t do that is wasting their time. I will admit though, I spend more time playing with numbers on lendstats, then looking at listings.

Charlie H
Charlie H
Jul. 22, 2011 8:52 am

@Bilgefisher
“Much of my net worth is far from liquid” I know that is true for me. My 401k and home make up a about 2/3 of my net worth. Neither are liquid. The remaining portion is in cash in the form of an emergency fund, a broker account, and Lendingclub.

The Lendingclub account makes up ~5% of my total net worth, but is 18% ex-home and ex-401k. I’m thinking 20% is pretty much my near term top end.

Lendingstats is a great tool. It an open source data mining tool that is powerful. I’ve found some of my “common sense” filters didn’t perform any better then average and have adjusted them based on using Lendingstats.

Bilgefisher
Jul. 22, 2011 12:56 pm

My whole lending criteria changed after studying lendstats data for many hours.

Moe
Moe
Jul. 30, 2011 1:36 pm

, I just saw this on Lending Club: Regardless of your state of residence, you may not purchase notes in an amount in excess of 10% of your net worth (exclusive of the value of your home, home furnishings and automobile). https://www.lendingclub.com/kb/index.php?View=entry&EntryID=113
Prosper on the other hand lists this limit only for Idaho, New Hampshire, Oregon, Virginia California and Washington. I’m pretty sure, Lending Club has it wrong on this, an only in certain states this limit applies.

Lending Club also writes: Investors who are residents of states other than California or Kentucky must have (a) an annual gross income of at least $70,000 and a net worth (exclusive of home, home furnishings and automobile) of at least $70,000; or (b) have a net worth of at least $250,000 (determined with the same exclusions). In this as well, Prosper lists the limit only for these few states.

ap999
ap999
Aug. 9, 2016 4:22 pm

10% total of your investable assets seems like a reasonable target to reach when starting out. Currently I am around 6% and slowly adding with new money as time goes on.

my personal target is 5% in Lendingclub, 5% in prosper, and another 5% in real estate crowd funding deals. So all in all 15% targeted to lending platforms. I have been investing in Lendingclub for about 3 years now, I never went all in, but instead just added new money the more I felt comfortable.

Being in my early 30s, I still have a large time time horizon to take added risk without worry about it too much.

This should all be based on personal risk tolerance, and this will differ person to person.

pha999
pha999
Sep. 23, 2016 1:15 am

I am creeping higher and higher in terms of how much I have invested of my net worth into p2p investments. Currently prosper and lendingclub sit about 8% of my net worth with almost equal amounts in each. I have also got about another 8% into real estate crowdfunding platforms too also. Looking to add another 4% or so making it a nice even 20%. Thinking of adding to another platform possibly or just add a little extra to lendingclub and prosper. We will see.

then again I am 32 years old, single, no kids, don’t own a home, no debt, make over 120k a year in my day job. So in terms of risk and time I feel very comfortable. I plan to early retire from the day job around age 36 to 40. I could probably retire now with what I have already accumulated if I wanted to live the real spartan life style. But I prefer working and keep adding to the nest egg for the extra cushion.