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Two Monday Thoughts About Prosper

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If you've spent any time in the archives or if you are a long time reader, you'll know that I used to write about Prosper.com quite often. I've since taken this blog in a more general finance direction. However, I find that I need to continue to cover the peer-to-peer lending space since it's quite possibly the most new and exciting thing to hit personal finance in some time.

First up, Prosper launched their own blog last week. I had the opportunity to talk with their Chief Marketing Officer more than six months and made this suggestion. I'd like to say that I'm the reason it got off the ground, but I imagine it might have more to do with Lending Club's Blog. The bigger news, at least for readers of this site, is that I'm writing for Prosper's blog. In fact you can read my first article about multiple income streams which came out today.

Now that I've firmly established the bias I have for Prosper and peer-to-peer lending in general, I'd like to highlight the other side of the story. Free Money Finance decides that investing in Prosper isn't for him. Here are the reasons he's highlighted:

  1. Stock index funds will average about 10% return over the long-term. That's roughly what Prosper loans earn too -- at best. It could be 1% lower. And we all know that over a couple decades, that 1% can make a really big difference in your total investment return.
  2. The Prosper loans take a lot of time to select and manage -- at least more than index funds do. The latter are easy, especially when you set up your investments automatically.
  3. Index funds seem less risky. It's not that stocks are without risk, but do I really want to lend money to someone who can't get a loan from a bank? Think about it -- people who do this professionally (bankers) have said this person is a bad risk. So why do I want to give them money.

I've read these reasons before and on the surface they make a very convincing argument. However, when dig under the surface some of these are not 100% true for all Prosper loans. I'll give counter points in order:

  1. It's very tempting to take the average Prosper loan as what your performance would be. When we talk of the stock market it's been documented that monkeys throwing darts at stocks don't beat the average performance. However, when you are evaluating Prosper loans, this isn't really the case. You don't have to settle for average if you read my keys to Prosper success.
  2. Prosper loans don't necessarily have to take any time to manage. I can go months or years without logging into my account, yet my money can be invested on a regular basis. You simply set up automatic withdrawals from your bank and then set up standing orders to bid on quality loans. Another alternative to this to take Prosper's portfolio plans which earn up to 11.56%. Who wouldn't mind that, especially with no work attached?
  3. I'm not sure how index funds seem less risky. The assumption with this one is that someone on Prosper can't get a loan from a bank. I never understood this assumption, but perhaps someone will explain it to me in the comments. I personally would rather not deal with a bank, if there's a choice of going online. It's similar to buying a stock through an online broker vs. the traditional way of calling up a stock broker. The old way takes longer, costs more, and is simply less convenient.

In the end, I don't see how peer-to-peer lending doesn't win. If you think about banks, they are happy to give you somewhere from 1 to 4.5% interest on your money so that they can lend it out to people at rates that are often more than 12% or 15% - even if you have very good credit. The banker collects that fee of 8-10% for his work. Peer-to-peer lending comes along and says, "We want 2% of that banker's cut and will give you the rest for doing his job of evaluating risk. Oh and if you want we'll help you evaluate risk by allowing you to invest in historically good loans." That sounds like a disruptive industry if you ask me.

Last updated on July 29, 2011.

This post deals with: ... and focuses on:

Prosper

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33 Responses to “Two Monday Thoughts About Prosper”

  1. The other issue with Prosper (and other P2P lending sites) that is not mentioned in Free Money Finance’s analysis is taxes — interest on loans is taxed as income. A stock market index fund pays out in two ways — dividends and price appreciation. Both are taxed at a lower rate than income and the tax on price appreciation can be postponed indefinitely.

    On diversification in a small investment, an index fund is certainly more diversified. Take a $500 investment as an example. If you buy the SAP 500, you purchased a share of 500 companies (who are audited) versus a maximum possibility of 10 loans on prosper or 20 on lending club.

    The assumption with this one is that someone on Prosper can’t get a loan from a bank. I never understood this assumption, but perhaps someone will explain it to me in the comments.
    There seems to be a perception that people only come to Prosper after exhausting other alternatives. However, that cannot entirely be the case because there are some people requesting loans who have decent credit ratings who could obviously borrow elsewhere.

    One interesting item for potential borrowers, I was looking at Zopa and realized that, with help from lenders, some borrowers are possibly receiving loans with an effective negative interest rate.

  2. Randall says:

    I did a piece on Prosper a little while ago, but my objection to them, being a personal finance blogger too, is that they either don’t do enough good for the consumer, or still harm them by making high interest loans to people that obviously have problems with their money.

    It didn’t sit with me on a personal level that I might really be a part of the problem, while thinking I was part of the solution.

  3. RateLadder says:

    Now that you are writing for Prosper might we look forward to a more regular p2p lending post?

    Perhaps including a post or 2 from the p2p lending blogosphere in your weekend roundup?

    I think your Prosper work is some of your best. I would not have become a regular reader without the Prosper component of your blog…

    Now I am hooked…

    btw — Taxes and small amount diversification are excellent points.

  4. Danny Tsang says:

    The portfolio plans look interesting with prosper. I’ve been slacking, I’ve been meaning to give prosper a shot, for the sake of diversification and just trying something different. I do agree with the first commenter however, we won’t get the long term tax-free compounding effects that an index fund would have..but nonetheless you will be dependent on the hope that the market would continue to rise at historic levels forever…

  5. dc_publius says:

    In your rebuttal to point 1, you link to a page that says that your rate of return is 12.76%.

    My question is, is this return still current?

    And second quesiton, is this annualized return, or do you only count the time your money is in play? There are complaints that it takes a while to reinvest and money is sitting still at prosper, and such delays can have huge negative impacts on your annualized rate of return. There is no such drawback with Index funds.

  6. Lazy Man says:

    DC: In that post, I said what I was making at the time. Of course it’s 9 months later. I haven’t done the math the last two months because I’m lazy. So your answer is that it’s not current, but I don’t have a current number to give you. I also admit throughout the site that I made a mistake of lending poorly.

    I show the methodology that I use to determine the percentage. The source I got are from smarter mathematical minds than my own. I believe the IRR calculation to include the delays in which money isn’t invested.

  7. Seth Gitter says:

    The S&P 500 has about a 50 year track record. The Dow about 100 years. Prosper has been around a year or two right? It might be a little earlier to declare on average prosper will beat major indexs by 1%.

    I do look forward to your Prosper blog, its a great concept and as an economist I’m carefully following it.

  8. MonkeyMonk says:

    FMF also makes the erroneous statement in #1 that “stock index funds will average about 10% return over the long-term.” Index funds *have returned* an average of about 10% over the long term. It’s always worth reminding people that nobody knows exactly what they’ll return going forward. There are 20-year stretches in the history of the stock market where an index return could have returned you close to a 0% return.

  9. CheapsterBob says:

    Before looking at anything be sure you are taking advantage of your companies stock purchase plan. Many people overlook this benefit which generally guarantees a 15 percent plus return every time.

    I’m happy that the Lazy Man has acquired a new employer but leaving out information on Prosper’s loan default rate?

    Shame, shame. :)

  10. Lazy Man says:

    CheapsterBob: One shouldn’t assume that I’m employed by Prosper.com. One could imagine a scenario where I might take the gig to draw traffic to this this website for which I most definitely am paid.

    I didn’t say anything about Prosper’s default rate, because I used overall return. Isn’t that what matters?

  11. I can’t get over the risk and lack of a track record with Prosper. Maybe if people are making 9-11% over a 5 – 10 year period it would look more reasonable to me.

    You can buy mutual funds with better than 10% returns for more than 10 years. That is a much more reasonable track record to make an investment decision on.

    I think it is fair to include Prosper in a speculative portion of your portfolio, after maxing out retirement contributions, if you want to try a little extra diversification. Beyond that, I don’t really see a compelling reason to use it. Not that I have decided to never try it yet- I am keeping it on my radar.

  12. CheapsterBob says:

    You did give an objective analysis as you provided both arguments. I just felt default rates should have been focused on as they apparently are rising during the current credit crunch.

    By “employed” I simply meant you were working for them. I obviously have no knowledge of your agreement with that site. In my opinion you should be compensated for your work outside of cross promotion. :)

    Regardless, good piece and best wishes to you.

    Best regards,

    Cheapster Bob

  13. FMF says:

    Here are my responses to your thoughts:

    1. The performance of your Prosper loan could also be BELOW the average. As far as I know, there’s no guarantee of performance, unless you’re offering a guarantee to people using your guidelines.

    2. I guess I need some more information on how these loans take less time than say bond index funds (which take virtually zero time.) I also note that you say the returns can be “up to 11.56%” In that case, let me say that stock index returns can be “up to 30% or more!”

    3. If someone is paying a high rate of return for a loan (which they would have to be in order for you to earn a decent return), it’s likely that they are paying a higher rate than what a bank would offer. So why are the doing this — because they like to pay more? Probably not. The most likely explanation is that they are not able to get a bank loan.

    Other comments:

    Good point on taxes from Personal Loan Portfolio. As far as “there are some people requesting loans who have decent credit ratings who could obviously borrow elsewhere. ” Sure there are “some” of almost any kind of people in any large group. But the exception doesn’t make them the rule. Besides, if a large portion of them were great credit risks, the lenders would be earning pretty low returns — something they say they are NOT doing (though the numbers appear otherwise.) You can’t have it both ways.

    Money Monk — Of course, there’s no guarantee on any sort of investment. But would I rather bank on decades of data with the stock market or a year or two with Prosper? Seems like the answer is easy.

    In the end, it doesn’t really matter what anyone invests in to me. I’ve been earning over 16% compounded growth in my net worth for over 15 years now, so my strategy has been working fine, thank you. If you’d rather do something else, that’s certainly your choice.

  14. Lazy Man says:

    FMF responses:

    1. Yes, the Prosper loan could be BELOW the average. In fact my loans are below that average. I admit that I didn’t know much at the time, but having learned I’m better for it. I also learned some “cool math stuff” along the way. So I took a little hit, but I’m more diversified and going forward I stand a good chance at 12% returns on average.
    2. I shouldn’t have said, “up to 11.56%.” I meant to say that’s the agressive automatic portfolio’s average return. It can return more or less. There’s also a conservative portfolio which is around 8.xx%. Of course it can be more or less as well. The point is to compare these numbers with the 10% stock market numbers since both are averages. (Whether you want to dispute Prosper.com’s ability to return those numbers long term, that’s a different story.)
    3. “If someone is paying a high rate of return for a loan (which they would have to be in order for you to earn a decent return), it’s likely that they are paying a higher rate than what a bank would offer.” I don’t know why this is the case. Banks have overhead of that loan officer who has to be paid. In this case, Prosper sets up a market equal for both sides and takes the spread. This spread is about 2% (or whatever Prosper’s average take is) where the banks seem to be much more.

    It is worth noting that people are good credit risks. While they may be exceptions that’s okay with me. I can pick them out and only invest in those people. I don’t have to worry if 99.9% are horrible, horrible credit risks. That’s really the difference here. The lender isn’t stuck lending to the average borrower. I personally only reinvest my money in people with B credit grades and up (typically an 680 credit score). Typically, though I’m focusing on the A credit grades.

    I simply think that Prosper deserves a fair look for a small part of a well diversified portfolio. I never argue that it should be the majority. I’d suggest simply 5%, maybe 10% if you are aggressive. Like many other investments it’s a hedge.

  15. RateLadder says:

    When I said “Prosper work” in my comment above I meant his writting on this site about Prosper.

  16. limeade says:

    What I’ve gathered is that there are multiple options of how to invest your money. Everyone has to make that decision on their own. You can make money through prosper and the stock market, and you can lose money both ways.

    I’m not too interested in Prosper since I have other avenues available to me such as hard money lending.

    We all do what we can to get ahead and I wish all luck with their chosen path.

  17. PFT says:

    Due to the above discussion on the tax impact on a Prosper loan investment versus an investment in the S&P 500, I posted this tax analysis which shows the power of deferring taxes and paying capital gains rather than income taxes.

  18. Don’t know how common this is within startups, but Prosper has had at least 5 CMO’s in the last (less than) 2 years. They average about 4 1/2 months. Whomever you spoke to in the CMO position six months ago is not the person who holds that position today, and, if history is any guide, neither will the person who holds it today be the person who holds it six months from now. The new blog is about information control. It has a hilarious feature which stores user comments in cookies, so that whomever leaves a comment thinks their comment is being displayed – when, in actuality, the only comments that anyone else who reads the blog will ever see are those which have been approved for public consumption by Prosper. Devious.

    For whatever it’s worth, I still unhesitatingly recommend Prosper to borrowers.

    -t

  19. William Barnwell says:

    I pointed out to Lazy Man yesterday that his Estimated ROI according to lendingstats.com is -2%

    Then he said he didn’t actually know after the fact.Lazy has over 25% of his loans late on prosper.com

    Here is the proof..This isn’t meant as a flame to him but he admits to not being up on prosper like he should be.BTW a group of us have posted over 100 comments on the prosper blog & not 1 have made it through moderation.

    http://www.lendingstats.com/lenders/TechnologyGuy

    [Editor’s note: For a variety of reasons I consider LendingStats to be low. As an example, Eric’s CC is 2% higher. Also my current strategy has returned nearly 5% using this low estimate from Lending Stats.

    I don’t admit to not being up on Prosper. I simply suggest that I have no interest reading forums and analyzing every last nuance of every loan. I’m much too busy for that. The average person should have better things to do with their lives.]

  20. Billy Horton says:

    “I’ve since taken this blog in a more general finance direction” — aww, not getting enough google ad click revenue I see.

  21. 112233 says:

    Nice site. Thank you for allowing a serious and balanced discussion about prosper to take place. This is not possible on Prosper’s blogs and forums.

  22. Lazy Man says:

    William, just to clarify, I knew the exact number of late loans I have on Prosper. I have admitted many times that I funded a lot of E grade loans. I no longer do this. That’s where almost all of the late loans come from.

    I also said that I didn’t know that Lending Stats projection. This is simply because Lending Stats went dormant for a couple of months. It stopped updating stats and I stopped going. I’ve mentioned the too that I’ve used in the past, the IRR spreadsheet.

    Billy, if you read the first post on this blog, it was never meant to be p2p lending blog. It was meant to be a record of my financial doings.

  23. Johnn says:

    I used prosper to finance a large appliance purchase and pay off a couple cards. Prosper does not charge outrageous fees like credit card companies! I fully support Prosper!

  24. Jack says:

    What about defaults? Are defaults counted in the statistics that track return? What if somebody defaults on a loan that has 50% of principal yet to be paid?

  25. Lazy Man says:

    Jack: Of course Prosper counts defaults. It wouldn’t be worth a hill a beans otherwise

  26. William Barnwell says:

    Lazy,i would also like to point out that you post that prosper is a revenue stream when all you are doing is returning capital that you invested,with no interest.

    [Editor’s response: I’d like to point out that the IRR lending sheet shows that I’ve been receiving interest. I use the average number to determine how much of a revenue stream it is. This is the best estimation I’ve seen anyone be able to do.

  27. Allan says:

    Beyond the fact that Prosper is in a state of constant change, how on Earth can we encourage people to dive in now?

    I agree that this very well may be the future, but it isn’t the now. Wait it out until someone executes on the idea well.

  28. Allan says:

    And in response to your response to William, have you had any go 4+ late? Then you’ll get a better picture of what your true returns might be… Prosper doesn’t publish estimated returns and the don’t write off accounts until they’re sold.

  29. William Barnwell says:

    88% of all loans that go 1 month late,end up defaulting..You don’t have to wait 4 months to figure out defaults..Yes,i have a default..My lender name is 2008

    http://www.lendingstats.com/lenders/2008

  30. Tom says:

    LazyMan – glad to see you are writing for Prosper and they started a blog. I’ve been writing for Lending Club for a couple of weeks and it’s quite a bit of fun. This is and exciting growth area.

  31. MP says:

    Okay…first I have to say, I started at Prosper, on your Prosper blog entry (I believe the first) and I liked it, which brought me to Lazymanandmoney.com, and then finally to this blog itself.
    1. I have it bookmarked already, and that’s pretty good considering I read MSN money religiously and have yet to bookmark that.
    2. I just took out a loan on Prosper.com even though I am VERY able to get credit through more traditional outlets, my reason for doing this is I know I’m a little better than my credit score, and with a p2p you get to explain to possible lenders why you might be a “C” instead of a “AA” or “A”. I shot for a lower rate than Prosper recommended I should shoot for…and ended up with even lower than what I asked for. THAT is why people choose Prosper (or p2p’s) over banks. (I reminded of those commercials where the banker flicks the small business loan seeker off his desk…Capitol One maybe.)
    3. I too would like to increase my alternative income, and I think Prosper will be one of my first avenues for acheiving this goal.

    Keep up the great site LazyMan!

  32. One 2 One Lending says:

    IF YOU GO AHEAD, PUT ALL IN WRITING
    It’s never easy to say no to a customer. But lending a financial hand can leave you out of money and out of sorts with your customers.
    According to One 2 One Lending, a company that helps formalize loans between individuals, about 14% of private loans end up in default, compared with just 1% or so for bank loans.
    To protect you financially, make sure you don’t fall for the top four costliest mistakes individuals make when lending money to customers:
    “¢ Not being suspicious enough. When someone comes to you for a loan, your first thought should be: Why? That is, why do they need the money, and why are they asking you for help?
    You also need to wonder hard why they haven’t been able to get a loan from a more conventional source. Point is: There are plenty of folks in the business of lending money. If your customer can’t get money from someone in the lending business, that’s worth two or three red lights going off in your head.
    “¢ Lending what you can’t afford to lose. Never lend money that you truly need. The best litmus test before you say yes is to ask yourself if you would be comfortable giving the money away.
    “¢ Skipping the formalities. Handshakes are not good enough for sealing a loan agreement. Put everything in writing. In fact, it’s a good way to size up the credibility of the person who needs your money: They should tell you right off the bat that they want to sign a formal loan document with you that spells out the terms of the deal. Once you have it filled out, all parties should sign it in front of a notary; it’s just a nice bit of formality to have in your pocket in the event anything goes wrong. In the document you want to spell out the specifics: What interest rate you will receive, when the payments are due, how much is due with each payment and what penalty will be paid for a late payment.

  33. Irina says:

    LazyMan, I actually want to ask your opinion about a borrowing idea from Prosper, as oppose to lending ideas…

    I have a perfect credit score, or so I think. I have no debt, except for my mortgage and I never late on any of my bills. I want to borrow on Prosper, say $10,000, and let the lenders know that this money will be used for sports wagering by my husband with the reference to his track record: http://mylifeandart.typepad.com/wagering

    I don’t really have to borrow this $10,000. I have the money. My goal is to create a public record (an open discussion) that intelligent sports wagering can be funded and returns can be good. Yes, sports wagering is a high risk proposition, but I know my husband and I am willing to take the risk.

    Do you think Prosper would allow a loan with such description?

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