Get Higher Yields By Purchasing Loans

Update: 8/30/08

Original post follows:

With the fresh .75% interest rate cut by the Fed and new cuts presumably to follow, yields on savings and money market accounts, and certificates of deposit will go from low to pretty much nothing. Treasury notes and bonds aren't paying much either, though bonds may make up for it by rising in value.

If you're thinking about putting more money in dividend paying stocks or corporate bonds to make up the difference, you may want to consider diversifying a bit by purchasing loans from regular people like yourself. A few so called peer-to-peer lending sites have sprung up recently. These include LendingClub, Zopa.com, and Prosper.com. There is also something similar called Loanio, which is not yet live. Currently, LendingClub "lenders" are earning an average of 12.15%, Zopa "investors" are earning "up to 5.1%," and Prosper lenders are earning from around 9.49 to 12.81%.

So far, I only have experience with Prosper. There, I've "lent" small sums to two people (more to follow), and am currently yielding an average 9.5%.

Prosper works in the following way. Potential borrowers need money, for business expansion, debt consolidation, etc (some of it is not so smart, actually, e.g., I saw a couple of people trying to borrow money to go on vacation). Prosper does thorough credit checks, gives borrowers a credit rating, and then lets potential "lenders" bid on their loans. "Lenders" can bid a minimum of $50 to a maximum of $25,000. When bidding, "lenders" specify the lowest interest rate they are willing to accept from the borrower. The lowest bids are accepted, and when, within a specified time (sort of like in an Ebay auction), the borrower's full amount is funded, the loan begins. The borrower makes monthly payments, which the "lenders" collect. Prosper charges the borrower a fee and also takes a small percentage of the repayments.

I've been putting "lenders" in scare quotes. This is because they're not really lending anything; they are purchasing loans. They are investors, but Prosper, the loan originator, calls them "lenders." (This is a great business model, and if Prosper were a publicly traded company, I'm pretty sure I would invest in it.)

At Prosper you have a choice between putting your money in portfolio plans, which are categorized by the credit ratings of borrowers and are supposed to spread your risk among many borrowers, and looking for borrowers yourself. For the latter option, there are a lot of criteria you can use in conducting your search, including borrower income, credit rating, past loans, etc. I try to limit my investments in people borrowing smaller sums (under $10,000) and for what I feel are legitimate reasons (financially). That is, I avoid the vacation people, because that's just irresponsible.

(A self promotional aside, but you get something out of it too: If you decide to sign up, note that Prosper offers $25 to new "lenders" who are referred. The referrers get $25 too. You get your money after you "lend" $50. Not a bad deal--a 25% return right away. If you're interested and need a referral, click here or on the ad at the upper right of this page.)

LendingClub, from what I understand, works very similarly to Prosper. As such, I do not have much to say about it. I encourage you to check it out. As far as I know, Lending Club also has a referral bonus. I am not a member (yet), so at this time I can't provide a referral link. Searching for lendinglcub referral, however, may help you get the bonus.

If you use the above sites, please remember that you're buying unsecured debt. The borrowers may default. While collection agencies can probably get you some of your money back, it pays to be cautious. Spread the risk among as many borrowers as you can.

You may have noticed that Zopa has a lower yield than Prosper and LendingClub. This is because Zopa works differently. It sells debt ("Zopa CDs") guaranteed by credit unions and insured by the National Credit Union Administration. In borrowing and lending, Zopa users become members of the participating credit unions. This is much less risky than Prosper and LendingClub, but your potential return is lower. Nonetheless, it is better than what you can get at a regular bank.

Although I've only talked about it from a lender's perspective, borrowers may be interested in these sites too. If you're a borrower, be sure to include the above sites in your comparison shopping. You might find a lower rate.

Finally, please note that these sites are relatively new. My own experience is limited, but so far I'm happy. You might want to look up user reviews before jumping in.

Happy investing.


What's Up with Bernanke?

I don't have the academic credentials of the Fed chairman, but it seems pretty odd that every time the market is set to drop a significant amount, the Fed lowers rates either on the Funds rate or the discount window. Stocks were tanking in August 2007, so the Fed cut the discount window rate by .5%. In mid September 2007, with the market tanking again, the Fed cut rates by .5%.

Yesterday markets around the world swooned. The DJIA, Nasdaq, and S&P futures indicated a big drop here. So what happens before the market opens? Bernanke cuts rates by .75%.

The cut can't be any more blatantly tied to the stock market. But is the Fed supposed to be worried about the stock market, or the general economy? Granted, the stock market influences the economy and the economy influences the stock market, but they are two independent entities that often go in different directions. There are probably economic reasons for another rate cut, but why should the stock market dictate when the cut comes?

The last cut sent stocks to new highs. This one, so far seemed to have an early effect on futures, but at the time of writing the DJIA futures are once again down 500 points. Will there be another .75% cut at the end of the month or sooner? If the market keeps going lower, I'd bet on it.

Just wondering, is Bernanke aware that eventually he will run out of room to cut rates? Is inflation no longer a top concern?

Trying to stave off a recession by papering it over with money seems like a recipe for disaster. Holding the recession off can turn it into a depression.

I used to have a good impression of Bernanke. (Not for any economic reason. He gave a C to one of my law school professors--one that I didn't particularly like--when she took his class at Princeton. That made him ok in my book.) Since the summer, however, I have my doubts. But only history will judge. Greenspan, for example, was thought to be a genius until recently. We'll see with Bernanke.

As we say good bye to getting any kind of return on our savings accounts, I'm thinking of waiting for a bear market rally to buy one of the inverse ETFs.


If You Must Time the Market, Buy Only When Fear Takes Hold

Repeated so many times it's become a cliche, I'm sure you heard this one of Warren Buffet's famous aphorisms: be fearful when others are greedy and greedy only when others are fearful.

It makes a lot of sense. That's how you buy stocks, and anything really, on the cheap.

So why don't people do it? Why do the majority of retail investors lose money on the stock market?

Small individual investors are fearful when times are bad, or are about to be bad--during a recession or when it seems there will be one. At such uncertain times, when you don't know how long your job will last, when there are no other job prospects in sight, and when the cost of your daily living goes steadily up all the while what stock holdings you've been able to amass plummet, it's hard not to be fearful. Putting money away for emergency use becomes much more important. Investing, if not a faraway thought, seems imprudent at such times. And rightly so.

For those with money to spare, however, fortunes can be made. All sorts of assets get cheaper, from stocks to land. They will eventually go up; history shows us this. For example, the Dow Jones Industrial Average nearly quadrupled from mid 1932 to 1937, after the great crash. Following every market downturn, stocks have broken even and then gone higher. Buying near the bottom, when others were fearful, has always paid off quite well.

It may come as no surprise that small individual investors rarely come out ahead after a market and economic downturn. Part of it is because of what's mentioned above--the fear. Part of it, however, comes from not following the other side of Buffet's advice: being fearful when others are greedy; and it is being greedy when others are greedy that causes the fear. For instance, it is somewhat common knowledge that an easy way to determine when the market has reached its peak is when individual investors enter the market. This is when one should become fearful.

It is said that that John F. Kennedy's father sold all his stocks before the great crash because he overheard shoeshine boys discussing stocks. From my own experience, when I was a wee lad during the height of the late 1990s internet bubble, one of my dad's acquaintances, a regular Joe, started talking about buying stocks, emphatically saying, "we have to buy those things--you know, those papers--stocks!" At the same time, the talking heads on CNBC were screaming that there was no top in sight. If you were watching CNBC in October when the DJIA reached its record high, you might remember the talking heads screaming that that was the bottom, and the sky's the limit. That's when you should cash out.

When should you start buying? When your uncle Charlie's lamenting about his stock market losses starts getting on your nerves, the screamers on TV are quiet and gray faced, and politicians have been talking about stimulus packages for a while. That's it. Don't buy at any other time. Save the money you would have used to buy stocks at their highs in an interest bearing account. Be patient. So you'll feel a little left out when the TV screamers are jolly, but you'll have money to spare when things are cheap.

Will you do it? No. Will I? No.

The temptation to buy when things are good is too great.