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I am calling it quits. The party is over. After 36 months of investing in Lending Club, I can’t see any reason right now why I should deposit and invest any more money into peer to peer lending. The returns are too fickle, the asset too illiquid, the tax situation murky, and its too difficult to find and invest in the best loans. You can see everything I've written about LC, including my 18 month and 2 year review here.
Ordinary Investors Crowded Out
The P2P market has become competitive beyond the point of usefulness because of the growing number of investors, both institutional (foreign sovereign wealth funds, Wall Street banks, and hedge funds) and individual. The best loans are snapped up in a matter of seconds after posting. The remaining loans are either too high risk or too low yield to be worth having in a portfolio, and even those are snapped up in a few hours.
The average investor isn’t supported by automatic algorithmic trading or can afford to hire multiple third world laborers to monitor the P2P sites when loans are posted at fixed times in the day. The individual investor can only use the Lending Club Prime service, which doesn’t offer enough flexibility in its automatic investing criteria. Even when using Prime, individual investors will often seen double digit percentages of their cash sitting idle, collecting no return. It is this idleness that is driving me to withdraw my funds from Lending Club.
The Idle Cash and Reinvestment Problem
To be honest, Lending Club requires too much work for the individual investor. In the stock and bond markets I can deposit a fixed amount from my paycheck every month which is automatically invested in low cost index funds in accordance with my asset allocation plan. When dividends are paid out, my Vanguard and TSP account are set to automatically reinvest the dividends.
There is no such system currently in place with P2P lending platforms. You can invest automatically by grade using the Prime service, but you can’t get into the fine details of loan investment, like only investing in people earning more than $100,000/year or ignoring loans from Florida or California. It is these kind of highly detailed investing that dramatically reduces your defaults and increases your return on investment (ROI).
It started off so promisingly. Only two years ago you could take your time to invest. Loans were funded in a matter of days, not minutes. I even remember reading in the loan details why people wanted the loan.
Obviously, as the P2P system proved to work, the sharks swam in. Big league investors can’t ignore an asset class that could return double digit yield with a bit of filtering and back testing. I think the initial glory days are behind us.
P2P investment will still be an exotic asset class uncorrelated with the returns on other asset classes (stocks and bonds, in particular), but it won’t be the 10%+ easy return we all thought it would be in the early stages. To get a return above 5%, you’ll need to put some work into filtering your loans. P2P lending in it’s current form is not a passive investment.
Lending Club Performance After Three Years – 8% Annualized Return
Nickel Streamroller has an excellent site with a new portfolio analyzer for both Prosper and Lending Club. Here was my performance with Lending Club since I first invested $900 February 25, 2011:
- Annualized Return on Investment: 8.18%
- Average Rate: 14.79%
- 95 Loans, 64 current, 21 fully paid, 3 late or in grace period, and 7 charged off
- Average loan age: 23.18 Months
- Loss: 5.63%
- Fees paid: $14.85
S&P 500 over the same three year time period: 11% annualized return, without dividends. Even with idle cash I still had an average annualized return of 8%. There is still some upside potential to Lending Club, it just takes an extra bit of effort to find those loans to match your investment criteria.
I haven’t made a deposit in over a year or invested in a loan since October 2013. From here on out, I’ll just divest slowly by withdrawing money as it’s paid back. The secondary market on Folio for loans isn’t bad for liquidating your loans, I just want to see how the rest of the investment plays out over the next few years.
Peer to peer lending is not dead. In fact, it’s still in it’s earliest growth stages. I wouldn’t be surprised if the P2P industry grows to loan a billion dollars per month in the next 5 years. Lending Club already loans a quarter of a billion every month in February 2014.
LC and Prosper have barely scratched the surface of the US credit markets. Right now most of the loans are issued to refinance existing debt. Just wait until P2P lending gets into mortgages, student loans, and automobile loans. P2P investment does have the potential to revolutionize debt markets in the US and around the world. By democratizing the meeting of lenders and borrowers, you take power away from the large banks and empower the common man.
Lending Club is an interesting alternative investment class, but as a young investor with a long time horizon, the world stock market and US bond market are the place for my cash right now. Low expense ratio index funds will continue to provide the cornerstone for my investment strategy.
I wouldn’t be surprised if in the next three years there are automatic P2P investment firms. For a 1-2% fee they invest your funds for you using their proprietary or open source models. P2P Picks is one such company, although as of February 2014 they can’t yet invest your money automatically for you. You still need to take action by clicking on the loans they select.
If, at some point, automatic and instantaneous reinvestment of idle cash into loans that match my criteria is available, perhaps I’ll return to Lending Club. Additionally, if LC offered at least some return above 0% on idle cash (like holding the money in an interest bearing money market account), that would ease some of the current issues. Until then, I’ll continue to maximize my Roth TSP and Roth IRA contributions.
How about you, reader? Are you jumping into the P2P game, on your way out like me, or just waiting it out?