In early 2012, I decided to jump on the most popular bandwagon in blogging (at the time) and get into some peer-to-peer lending. Initially I started off with $300, but quickly upped my stake to a total of $1,000 and then decided to let my experiment ride before I committed more money to it. Statistics showed that lending club investors were getting great returns, on average of 5% for “A” grade notes, all the way up to the much riskier “G” grade notes, returning 9.22%. The sweet spot seems to be mostly “E” grade notes, which return 10.22% on average (source). Things looked good to me, and it was sure better than the shitty ass <1% that H and I are getting for our savings accounts. Of course, I mentioned it to my dad and he looked at me like I had four heads, but also slightly curious.
Initially, my lending club experience was going quite well. After 6 months, I was convinced enough to up my stake in lending club from the initial 300. Everything was going good, and if I remember right my return was in the 8% range, which is more than adequate for what I was looking for (and I think a bit better than the S&P 500 at the time). Now that everything was going great, I figured this could become a pretty significant part of H and I’s portfolio going forward. We could use it to generate additional cash flow as well as get better returns than a regular savings account. Of course, in my initial excitement, I had forgotten that I was taking on quite a bit more risk than I was had I opened just a regular savings account.
After 9 months in, there was still no trouble in paradise. I had kicked my investment to the 1,000 range and was holding steady at an 11%+ return – not bad at all. I had even started taking on riskier notes. I started with A & B grade notes, with a few C grade in there for my first round, but the next round I was looking for higher returns and only was looking for B, C, D and E Grade notes.
I was making good returns in month 9, but still was looking forward to the awesome returns, though I did mention if I had a default or 2, I would still be much higher than I would in a regular savings account (you can see the increased risk had yet to sink in at this point), but I was totally happy with my return and probably would have put a bit more into it had I not decided to throw the last of the cash into the house so we could finally finish up some stuff upstairs. Since everything was going so well, I adopted the ron popiel strategy for this asset that I had built up:
Unfortunately, this strategy was rather poor, and my 10%+ returns were not going to last much longer.
Why you shouldnt leave lending club on auto pilot
After executing my awesome strategy, I decided to check in 3 months later at the 1 year mark and see how it was working. Unfortunately, I was greeted with a nice slap in the face (and noticed I was $50 poorer). I had 1 loan past due at this point, but 2 had already been charged off, and I was currently looking at losing about $75 in principal! This was rather shocking to me, as I had about 50% of my investment in the most secure, lowest returning notes (A & B grade) and another 22% in the C grade – Over 70% of my exposure was in the top half of their rating structure!
My return had plummeted, but I figured that the defaults were mostly behind me, so I decided to keep the money there and figured that I could ride out the bad loans. My friend joe over at retireby40 had a similar situation and saw his ROI drop after a few defaults, but then started to climb back up again after other loans kept paying back in full on time. I did know that this was a risk of the game, and had finally realized it, but only after it cost me $50. I was still ahead of where the banks were giving me, so I wasnt too worried quite yet. I’d just let the money sit, figure on no more defaults and then my ROI would climb back up around the 10% range and everything would be just fine. Unfortunately, these borrowers had other plans.
I noticed that one of my notes was late at this point, but instead of hopping on the trading platform to unload it at a partial loss, but I decided to do nothing and just blindly hope that the borrower would pay me back (not a good idea, FYI). It finally sunk in for me that I was probably taking on a bit more risk than I thought I was getting a return for, and even noted that had I simply tossed it into an S&P 500 index fund I would have been way better off. I was still fairly optimistic there though, and not really ready for what I would find a mere 6 months later.
How Low Can You Go?
During my 1.5 year check in, I realized that I really needed to pay more attention to this. I now had double the amount of defaults, and a few more notes that were late. This was not going well, and my return dropped below 2%. I had absolutely not heard of anyone with this poor of luck (friends were still earning 15%+ in some cases) but I still wasnt sure what I should do with it. Just over 1/2 of the term of most of my notes had passed, and I’d taken a bath! At this point, I had pretty well decided that I needed to back out of it, I just wasnt sure how to price my notes on the secondary market, so I basically sat on my hands for a while.
Eventually, my Return dipped below .75% and I got fed up. It was time for me to make a move before I got killed with this even more. Unlike losses in the stock market, these arent “paper losses” and are immediately realized when the borrower defaults. At least in the market there’s a chance that your holdings can increase in value after falling – not so at lending club.
Also at this point, I was saving up some cash for tax lien sales. Though I only got about $100 worth of tax liens this year, I’m hoping to increase that next year by going to sales in more counties. I’d also like to be able to sink a few hundred (or thousand) into a property that I feel like will be paid back, just for the sure 18% return.
Finally, I ended up taking some action and put a block of notes up on foliofn for sale. Not all of them sold, but some of them did. I decided that I wanted to back out half of my portfolio (not sure why just half) and am selling them in blocks as they come up. I’ve gotten about 20% of my initial investment back at this point, with about another 50% of my investment on the trading block. I dont expect all of those notes to sell within the week time that is allotted, but some of them will and I’ll be able to move the cash out of lending club and back into my bank account, where it will be reinvested somewhere else. Right now, I dont have a plan for it and it will just sit in cash, but I’ll probably open a brokerage account and fund it with these proceeds. If things go well, I may just back everything out of my lending club account.
I can say that I do like the lending club idea, and I honestly think that I just had a bit of bad luck and I didnt screen the borrowers that I was lending to close enough. I also think that I didnt have a large enough balance to swallow the defaults that were coming my way. Lending club recommends a balance about 20x the size of what I had, and I think that would be enough to swallow the defaults that I was experiencing and still come out with a very solid rate of return – somewhere in the 8-9.75% range if I followed the same allocation as I had before.
I may decide to build this portfolio back up in the future when I’ve got a bit more cash, but right now me and lending club are on the outs, as you can see from the picture above. I’ve sold off 35% of my holdings, and plan to sell off more.
The odd thing about this entire situation is that many of my friends also signed up for lending club, and have been absolutely killing it. They’ve enjoyed anywhere from 8% on the low end (Joe) to 11% in the mid range (eric), and a personal friend without a website juiced returns up to 19%, before falling back to around 16.5%.
Readers: Do you use lending club or its friend prosper? If so, how have you been doing so far? How long have you been investing, and how much total do you have invested?