In my previous articles on P2P lending, The Basics of Peer-to-Peer Investing and Peer to Peer Investing – Facts and Figures, I discuss getting started in P2P lending and some of the basic facts and figures pertaining to notes on Lending Club, a P2P platform.
After keeping a small (~$750) portfolio on Lending Club for about 18 months I’ve discovered some of the downsides of only having a small amounts invested on these platforms. Below I detail why I decided to cash out and end my P2P investing career for the time being.
The primary downside of having a small portfolio in P2P lending is the capital requirements. Having a small portfolio, thus a smaller number of loans, means each default will have a huge negative impact on your overall return. Before any defaults I was earning ~12-14% returns on my portfolio, after a couple of defaults this return rate effectively halved. Of course, the actual numbers will be affected by how quickly a loan defaults in it’s lifetime, i.e. a loan defaulting the first month will drop the return rate much more than one in its last month.
To mitigate this downside risk, one can provide a constant inflow of cash to replace defaulted loans with new ones. Alternatively, the investor could keep reinvesting the principal and interest payments each month to replace the defaulted loans. Both of these strategies will replace lost principal with new interest payments, the latter being less effective than the former.
These risk mitigation strategies will both, effectively, take money out of your pocket. Obviously making additional deposits to Lending Club takes capital directly from your bank account, but you might be thinking how does reinvesting my returns take additional capital from me? When I started P2P investing the idea was to keep the principal payments invested while realizing the gains paid as interest. In actuality, I was required to invest both forms of payment to keep my portfolio afloat.
Are we to keep our money in P2P notes forever and never actually realize any gains?
Although most P2P lending platforms offer automated portfolios, without really knowing how they determine which loans to place in their low, medium, or high risk portfolios I have a hard time trusting the process. Because of this I spent the time to pick my own notes. In doing this, I research the person’s employment, cost of living in their area, credit factors, and their debt-to-income ratio before and after taking the loan. Doing this for a small portfolio is manageable but for larger portfolios I would consider, and recommend the automation.
Either way, since my portfolio was so small and I needed to find a good balance between upside potential and downside protection I was evaluating each investment opportunity individually. Since I needed to do this practically every month it was taking a lot of time I felt could be better spent elsewhere, due to my ‘gains’ problem mentioned above.
Troubles Within Lending Club
The final nail in the coffin, although the least significant reason, was with the management at Lending Club. In 2016(ish) it came out that some executives at Lending Club were accused of scandalous behavior between the company and some investors. This landed Renaud Laplanche on a list of the worst CEOs of 2016. I believe the CEO has since stepped down (or been fired) and the I’m sure the company is well on it’s way to integrity and stability. However, at the time I didn’t feel being tied up with a company facing litigation was in my best interest.
The reasons above have forced me out of P2P lending for the time being. However, I still find these types of investments attractive and would certainly consider creating a new portfolio in the future. Having learned what I’ve learned during my first run at P2P investing, though, I would try to start with higher capital, probably around $4,000, since defaults in larger portfolios have less effects overall.