Tips from a Pro
I asked my friend George Alex Popescu to provide some expert insight on P2P lending. George is the founder, CEO, and editor in chief of Lending Times, a media company that publishes in the peer-to-peer and alternative lending space Over the last ten years, George founded ten companies in online lending, craft beer brewery, exotic sports car rental space, hedge funds, peer-reviewed scientific journal, etc. He has advised dozens of early stage start-ups in different fields and was a mentor at MIT’s Venture Mentoring Services and Techstars Fintech in New York. In short, he knows his stuff.
George Alex Popescu:
The best advice that I could give any investor is to put some real thought into diversifying to manage risk. Investing in peer-to-peer loans is already a great way gain diversity from your other investment such as real estate, stocks, and bonds. Most new P2P investors spread their funds among many small loans, and that is a great start. Investors should strive for even better diversity by spreading funds among a few different platforms.
Lack of liquidity can also be an issue for some new investors. If you buy into a three-year note, you’d better be absolutely sure that you won’t need your money back sooner. I have heard of many investors who suffered big losses trading out of their notes early. Think of these notes like a bank CD that you cannot cash in until the term is up.
Finally, consider investing through your IRA to save on taxes.
What Can Go Wrong? Common Pitfalls to Avoid
The most common error that investors seem to make is reaching too far for higher interest rates. As with most investments, higher reward carries higher risk. When reviewing the list of loans, your eye will naturally be drawn to the rates in the high teens, and investors can be guided by greed into a portfolio loaded with defaults. An experienced and disciplined investor will study the historic rates of default and net return for each grade level and then select a portfolio of loans that fits his or her risk tolerance. Keep in mind that historic rates of default may not continue. As the economy cycles up and down, default rates will change.
Another common pitfall is failure to diversify among many loans. Simply put, don’t put too many eggs in one basket. Both of the major P2P platforms allow investments of as little as $25 per loan, so take advantage of that and spread your funds out as much as possible. Never fall in love with any single loan regardless of how much it may appear to be a “sure thing.” Also, consider spreading your funds among a few different P2P lenders.
Summary of the Pros & Cons
Pros
- High Interest: Interest income is comparably high in comparison to similar investments.
- Diversity: Investment in consumer loans provides a hedge against other investment asset classes such stock or bonds.
- Control: Investors manage risk and income through individual selection of loans-based filters and loan grading.
- Spreading Risk: Investors may diversify with many loans at low ($25) values to spread the risk of default.
- Automated Option: Investors may use automated models to build portfolios of loans-based on preset models
- Time, Funds, & Expertise: Unlike many of the investment options discussed in this book, peer-to-peer lending does not require a lot of time, money, or experience. Investors can start with just $100, and the websites make the process quick and easy.
- Helping Others: Loans that investors fund may help the borrower pay for education or pay off higher interest loans.
- Scalability: It is exceptionally easy to scale up this investment from $100 to $100,000. Management of many loans is especially easy though the automated investment option.
- Cash Flow: Interest payments are transferred directly into investor’s account each month.
- Taxes: Although the interest income is fully taxable at the investor’s income tax rate, investors may open accounts through an IRA or Roth IRA to shelter the income.
- Stability: No “market swings” like the stock market or mutual funds.
- Professional Assistance: The P2P sites prescreen and grade loans for investors, process and distribute the monthly payments, and manage the collection process upon default.
Cons
- Interest rate fluctuations: As interest rates increase in the generate market, the value of fixed-interest loans decreases. This risk applies to all fixed-rate income investments.
- Risk of Default: Unlike a bank deposit or bank CD, these loans are not FDIC-insured. There is no guarantee of repayment. Borrowers will default on a percentage of loans, and it will reduce the investor’s return. Additionally, the grading supplied by Lending Club and Prosper may be inaccurate, underestimating default risks.
- Control: Investors have no control over collection efforts when loans default.
- Unpredictable Cash Flow: All loans may be paid off by the borrower at any time, so future cash flow and interest may be unpredictable.
- Untested: Relatively new asset class has not been tested through long-term economic cycles. Periodic recessions will have negative impact on default rates.
- Illiquid: This is a long-term investment. The loans are for three- or five-year terms. Although there is a secondary market to resell loans, it could take weeks to cash out, and the resale value is based subject to demand from other investors.
- Fees: Lending Club and Prosper charge fees for collection efforts and payment processing. The fees could be increased in the future.
- Restrictions: Not available to investors in some states, and in some states investors must be financially qualified.
- Security & Priority: These loans are unsecured and low priority in collection efforts. They may be eliminated through bankruptcy and are behind all other secured debt such as mortgages and tax liens.
- Failure of the Servicer. While it seems unlikely, it is possible that Lending Club, Prosper, or any of the other peer-to-peer lending companies could fail and file bankruptcy. The underlying loans should not be directly affected and there are contingencies in place for orderly liquidation, but this could disrupt cash flow to investors.
Publicly Traded Alternatives
On-Deck Capital : ONDK
Hungry for More? Source Books, Consultants, Websites, and Sellers
Peer-to-Peer Lending Sites:
prosper.com ondeck.com Uhaulinvestorsclub.com Realtyshares.com Sharestates.com Realtymogul.com
Books:
A Beginner’s Guide to Lending Club, Adam Davidson Building Wealth through Peer-to-Peer Lending, David Shipman Cutting Out the Banks with Peer Lending, Dale Poyser How to Profit from Peer-to-Peer Lending, Scott Todd The Complete Idiot’s Guide to Person-To-Person Lending, Beverly Harzog and Curtis Arnold Understanding Peer-to-Peer-Lending, Peter Renton
Websites:
Lendingrobot.com
(To be continued...)
This excerpt is taken from “How to Invest in Debt: a Complete Guide to Alternative Opportunities” by Michael Pellegrino. To read other articles of this book, click here. To buy this book, click here.
The Epoch Times Copyright © 2023 The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
