Which Type of Marketplace Lending Investor Are You? I’m #3

When I started investing in marketplace loans in 2013, it was still called peer to peer lending or p2p lending. There were also only 2 options. Professional and accredited investors have many more options for investment. Banks have gotten on board since then offering platforms of their own.

For retail investors we now have more than just the 2 big lending platforms at our disposal in the US: Prosper and Lending Club. We have 8 options, 7 of which are outlined in my book (the 8th wasn't available then) P2P Investing 101: Why the Smart Money is Investing in Peer to Peer Loans, which you can get on Amazon.

Rates have been so low for so long on bonds, other fixed-income investments, and dividends. These low rates make it a good time to revisit and update this post from 2014 on why you should invest in marketplace loans based on the type of investor you are.

As retail investors, we invest for many different reasons.  Below I have identified 5 different types of peer lending investor. Which one are you?

Type 1: The "Savings Account Substitute" Investor

The first type is the reason many of our baby boomer brethren are likely investing in these loans.  As we age, we move from accumulation to distribution. Accumulation is when we try to grow our investments. Distribution is when we preserve our principal and live off of the interest.  When investors hit the distribution stage, they are looking for safe investments that allow them to earn interest to live off of but does not pose a risk to their nest egg.  This used to be savings accounts and government bonds, both of which paid a decent rate of interest and were perceived as safe.

No longer. Today neither are considered that safe and interest rates are so low, they don't even keep up with inflation meaning there's a negative real interest rate. Europe actually has negative interest rates at banks. Enter marketplace lending. Spreading out the risk over many loans virtually guarantees a positive rate of return. Many investors are yielding between 5-10% without excessive risks. I know because I'm one of them and my returns were even higher back in 2014. However, investing in only the safest A rated loans still earns the Savings Account Substitute investor a yield of 5% or maybe more, more than 3 full percent (known as 300 basis points) above government bonds or savings accounts.  This is a great investment alternative for part of a retirement nest egg.

Type 2: The Yield Seeker

The next type of investor is the one who seeks the highest yield for the money that he can get. He may or may not have invested his money in penny stocks before but that can require a lot of capital to be properly diversified. Since we can invest as little as $25 per loan, we can diversify very easily while seeking yield by buying some B rated loans but lots of C, D, E and even higher yielding loans.

Since marketplace lending was first discovered by techies, many of them are big believers and evangelists of the platforms (thanks to you guys for that). They are also often the Yield Seeker.  They accept the risk that some loss is happening and will happen and figure it will all even out well to their advantage in the end.  For almost all loans made since 2010 on these platforms, that is proving to be true except for the 2015 and 2016 vintages, which I describe in these 2 posts Is p2p lending dying? and LC Returns: 2 Years Are the Drag.

Type 3: The "Other Than The Stock Market" Investor

Here is a type of investor I'm personally very familiar with as I fall into this category.  This is an investor who seeks to invest his or her money in something he understands and does not think is rigged against him.  Lots of people think there are system problems with the stock market that rig it against the smaller investor.  Even back in 2014 when I originally published this, 60 Minutes did a story on high speed computerized trading. The piece shows how the market is rigged in favor of those with the most speedy powerful trading systems.  It's a race for speed and us little investors lose.

I like that my returns in marketplace lending don't correlate with the stock market. Courtesy of this white paper from Lending Robot, as seen in my book

As an investor seeking to grow my savings for the future, I need a solid return over a long period of time with a risk that is low over the long term. For me, this is marketplace lending, at least for a portion of my savings. Now I'm looking at crypto lending as well as I look at sites like EthLend, SALT, MakerDAO and others but after my experiences on BTCJam and other Version 1.0 Bitcoin lending platforms, I am watching and waiting.

With my old commercial credit experience, understanding loans are something I already know about. Many people in the blogosphere, including me, have instructionals on how to learn to evaluate and filter loans for yourself based on your own tolerance for risk.  Search the posts for the Credit Analysis tag and you're on your way.  I am a typical "Other Than the Stock Market" investor.

Type 4: The "Stick It to the Man" Investor

Banks used to lend money to people.  They used to lend to small businesses for something other than buying a building and they used to lend to individuals for things other than buying a home. That has changed for the foreseeable future.

But starting in 2017, something funny happened. Banks decided they wanted to get in on this action and started partnering or building lending platforms. They are still WAY behind on the curve although there are a couple of excellent products like Lightstream, which is owned by Suntrust. And of course, this is only for the borrowing side, not for investors.

Most marketplace borrowers are consolidating their debts including high credit card interest rates into a lower rate loan.  When we invest in these loans, we are helping this borrower pay a much lower rate to consolidate this debt.  When a bank or credit card company raises their interest rates on good paying customers just because they can, it is infuriating and non-sensical.

As investors, we know they are good paying since we see on their loan listing when their last late payment occurred.  When we help this borrower, we are helping them stick it to the credit card company for doing this to them.  This is the "Stick It to the Man" investment philosophy. They invest both to earn interest and to stick it to the companies who are doing this to their customers.  I must admit there is a little of this in my investing too.

Type 5: The "Help Thy Neighbor" Investor

Marketplace lending when first introduced was Social Lending, then peer to peer lending.  In a previous post on how to tell your grandma that peer to peer lending is safe, the #4 reason I discuss is the Social Lending/Community lending aspect of marketplace lending. Sadly, this is something that is changing for the worse for us retail investors. We have fewer loan offerings across platforms as banks and funds take over with their vast amounts of capital. Today it is less community and more banking-oriented. Yet, there is still room for retail investors to pick and choose loans across platforms and make a nice return.

Social lending used to be the only form of lending before modern banking. A community would lend to a farmer for a tractor and he'd pay back out of his crop from that season.  While earning interest is a nice benefit, helping people in his own community is the mantra of the "Help Thy Neighbor" investor.  All Kiva investors are this type. I'm a big fan of Kiva by the way and have been for years.

Conclusion

While earning money is the end result, there are many reasons why we invest in marketplace loans.  My declaration of being a type #3, the "Other Than Stock Market" investor is true for myself but not 100% true. I know I like sticking it to the banks who are making it tough for their customers too, making me a type #4 investor too.  Of the 5 types, which do you most closely identify with or is it something not even on this list? I'd love to hear in your comments below.

 

About the author

Stu Stu Lustman, the author of this post, is a Credit Analyst by trade trying to bring Commercial Credit Analysis techniques to the world of Peer to Peer Lending. Check me out on Twitter, LinkedIn and Google+

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