Internet Loan Shark or Sage Investor? Peer to Peer Lending…

In one of my searches on side hustles, I found an interesting niche of peer to peer lending, or what is basically crowd funding of unsecured loans. My first reaction was not positive. I had watched documentaries of the sketchy behavior of unsecured loan companies, where people who were in tough spots were taken advantage, and basically had their life ruined. Title loans, pawn shops, and payday loans all fell into the same category for me: business that charge ridiculous interest rates to people that can’t afford basic living expenses. As I dug into this more, my opinion swayed.

The most recommended site appeared to be Lending Club. This is a crowd funding site where investors fund unsecured loans which are graded and managed. The rates charged here are based on probable ability to repay. Interest rates range from 6-8% for grade A loans, to 23-30%, but the effective rate after defaults for all grades is just less than 5%. Thats a fascinating number. Those in the low grade loans have massive default rates, so to achieve a reasonable return, the high rate is clearly justified. Lending Club provides stats, by class, and adjust loan criteria regularly to ensure that performance. I did not know this!

I started investing here, with my favorite method, which is a small amount and get a feel for performance, access and information, and have become a huge fan.

Loans, graded from A to G, with 5 sub grades each, are given to applicants with interest rates that range from 6% to 30%. The interest rate of my personal portfolio today is 11.6%, meaning I choose the higher grade loans, focused on A and B level. After non payments, or charge offs as they call them, that 12% should eventually hit 4.7%. In the first year, my return has been over 10%, but most loans don’t get charged off till later, and with 1-2 year terms, it takes over a year to see the actual returns.

I use automated investing, and the loan positions are only $25, so I have hundreds of loans. The more loans you have, the less variation and less risk to an individual charge off. The site has good analytics to show you this model. Payments received each month are re-invested, based on my % of loan grade choices. Its no effort, but I still look at it regularly and play with analytics they have available. Based on these analytics, I chose a higher grade portfolio for risk reduction, and after I was comfortable with the site and its functions, quickly invested enough to get over the 200 loan mark to reduce variation. I have currently gone well beyond the 200 loan threshold. Lending Club has a $44 billion dollar history, and regularly reviews loan grading methods, and has analytics on major economic upturns and downturns. I find this history, and their publications, a valuable source of information that I don’t get elsewhere. If the SnP 500 or the Dow take a 20% dip, it doesn’t translate to a dip in these returns. This fund is not impacted by auto sell triggers which are so prevelant in the market today. If you see unemployment spike on the other hand, you can expect to get hit.

I have a ‘pattern’ in which I like to invest. I want to try something out at a low commit level, and proves it does as advertised. If all is well, the performance is as stated, and it looks like they provide simple and easy tools I can navigate, I increase my exposure. If I don’t like it, then see you later. Also, I look for things that tend to cycle at different times. I don’t want my entire portfolio to cycle as the stock market cycles. The current corellation between the bond and stock market is very high, so standard portfolio theory, 100 minus your age for stock exposure, is no longer the gold standard. If you do have to invest like that, you better being doing it with a low fee account.

With the focus of the industry on the millennial investor who is extremely comfortable on line, there is a growing industry of on line high tech investment options, like Lending Club, but also in Private Equity, which previously was relegated to the $multi million portfolios. These tend to be low entry point to start, with high on line content and control, and almost always have an app on your phone where you can transact at least 80% of your business. If you are smack in the middle of the investment world, with a standard portfolio of stocks and bonds, not getting access to private equities or other high end investment options, you now have ways to get out from under the standard Financial Advisor model. These things were just not available 10 years ago.

Solid returns, hands on modeling data, little work required, and vast financial history, so whats not to like about Lending Club? These funds differ from my investment portfolio in that I cannot put in a request, and over the course of a week, get access to my money. You can trade your loans, but risk loosing money. If you want your cash, you terminate auto re-invest and let the money come in as payments are made and the loans clear. I put this in my bucket of illiquid investments and treat it as such. Its not the largest part of my portfolio, but it may actually be the most enjoyable, while delivering great returns.