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Why a Down Stock Market is Good for P2P Lending

by Peter Renton on August 9, 2011

With the stock market down almost 20% from its April high one has to wonder how this will impact peer to peer lending. While the down market is certainly not good news for anyone with money in equities, I am guessing the management at Lending Club and Prosper are quite happy with the latest stock market gyrations.

Since the 2009 lows the stock market has steadily rallied and those who stayed the course have seen their portfolios grow significantly. But the crash of 2008-09 is still fresh in investors’ minds and many people who have come back into the market in recent months are likely questioning their decision to do that now.

Where to Invest?

For people taking money out of the stock market where do you go? Yesterday everyone was flocking to gold as well as bonds, but these are also volatile investments. Sure you could keep it in a CD or money market account and earn next to nothing in interest but at least you will not lose any principal. I imagine that is what the majority of people are doing who are sick of experiencing the volatility of the stock market.

But some people will do some research looking for alternatives and discover p2p lending. Lending Club had a great deal of press coverage last week with their new funding round and high valuation and some investors may go back and revisit those articles. And Prosper also recently had a funding round and continues to provide outstanding returns for investors. Now, neither company will share these numbers publicly but I expect this week would be an above average week for new investor signups at Prosper and Lending Club.

P2P Lending Provides Steady Investment Growth

With a well diversified p2p investment portfolio you should never experience wild fluctuations in your holdings like you do in the stock market. I have been investing in p2p lending now for two years and in 23 of the last 24 months the total value of my portfolio has increased. My one down month was near the start of my investing when I didn’t know what I was doing and I made a big mistake of investing in a small number of notes and I had a $250 note default.

Now, with well over a thousand notes it would be virtually impossible for me to have down month again. With a total portfolio of around $100,000 (split across six accounts at Lending Club and Prosper) it is steadily growing at $750 – $1,000 every month. Try and achieve that with a stock market portfolio.

Borrowers Are Still Looking For Loans

It is no good to have more investors coming to peer to peer lending without a corresponding increase in borrowers. But there have been signs in recent weeks that borrower activity is picking up throughout the economy as referenced by this article from Friday by the Associated Press (hat tip to Ken from Lendstats). Consumer borrowing is at its highest level in four years and I would say that is good news for p2p lending. Some consumers will be turned down by banks or be looking for alternatives to credit card financing. Some of these people will discover borrowing money with p2p lending.

The Future if Uncertain

I have no idea where the stock market will be tomorrow, next month or next year. While there are no guarantees, I am confident that I know (within a certain range) the approximate value of my p2p lending investments tomorrow, next month and next year.

Now, I am not liquidating my stock market holdings any time soon, and I am not suggesting others should do that. But I will continue to put new money to work in p2p lending. I like, not just the great returns, but the low volatility of these investments as well.

What do others think? Have these latest stock market gyrations influenced any of your investment decisions. As always, I am interested to hear your comments.

 

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{ 32 comments… read them below or add one }

kay August 9, 2011 at 9:49 am

I would say that the market fluctuations have made my decision to drop my 401k contributions to the max employer match a longer term plan. A mix of smaller property investments and p2p lending looks to be my plan for the near future.

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Peter Renton August 9, 2011 at 1:54 pm

@Kay, Thanks for sharing. I think it is always a great idea of get the maximum employer match in a 401k so I am glad you are at least sticking with that. It is a great way to dollar cost average your stock market investments as well. I am glad you are including p2p lending in your investment mix going forward.

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Dan B August 9, 2011 at 8:23 pm

Personally no. But for p2p in general with other people, I don’t know. I had another pointless conversation yesterday with someone who was looking to deploy some new investment money. I went through the same spiel on p2p which I’m confident will lead nowhere. You can show them your returns, you can lay it all out, but unless you’re really trying to push this you’re pretty much just wasting your time…………….Better to wait until some investment guru comes out for it. Then I’m sure everyone will want in.

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Peter Renton August 9, 2011 at 8:50 pm

@Dan, Yep, the vast majority of people have still not heard of p2p lending. I think it can keep on it’s current growth rate with just the organic growth of a few hundred new people signing up as investors every month. But to get rapid widespread acceptance it is going to need the endorsement of someone like a Warren Buffet or Jim Cramer, and I don’t see that happening any time soon. Still, I think the current growth rate is fine and those of us who started early will have enjoyed the benefits that much longer when it does become mainstream.

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KenL August 10, 2011 at 9:25 am

Another -400 day for the DOW, yikes! How low will it go??? Luckily for me, my investment portfolio is no longer exposed to that wildness. My p2p lending portfolio, however, increases in value on a nearly daily basis. I’m diversified enough to be nearly 100% confident that the value of my accounts will only rise every month as they have for the last couple years.

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Dan B August 10, 2011 at 11:59 am

KenL………….On the other hand, the ‘average’ investor buying into p2p today will likely do no better than if he were to put that money into AT&T today and just hold it for 5-10 years. In fact he may well do better with AT&T.

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Dan B August 10, 2011 at 12:00 pm

And with a helluva lot less effort too.

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Peter Renton August 10, 2011 at 2:13 pm

@Dan, Putting significant money in any one particular stock be it AT&T, Apple or Exxon is foolish as I am sure you are aware. You could suggest someone choose a portfolio of high dividend paying stocks and make a comparison.

I would argue that a Lending Club PRIME account takes virtually no effort and will produce 8-10% real world returns year in year out. I think that will be a hard investment to beat over the next decade. Look for my LC PRIME update coming out tomorrow.

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Dan B August 10, 2011 at 2:23 pm

Not true Peter. The gazillion dollar mutual fund industry has brainwashed you to believe that. Before the advent of mutual funds no one would have argued that a basket of high dividend stocks was superior to one good high dividend paying stock.

Besides according to both the federal regulators as well as the p2p companies, “putting significant money” ie over 10% of your investment portfolio into p2p is also foolish & in fact a violation of the terms of service.

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Dan B August 10, 2011 at 2:26 pm

And whether any automated acct will do 8-10% LONG TERM is very much debatable. Results so far would say NO…………….as evidenced by the universe of results to date.

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KenL August 10, 2011 at 2:27 pm

Dan, you could be right. For sure you are right about the effort part. I like p2p lending because I have a pretty good estimate of what my returns will be for the next couple of years. I also like doing the statistical micro-managing that great returns require. If I invest in AT&T or a utility or the big MO, it certainly is possible that they could give better returns over 10 years, but the possibility of a crash would still be there and I just don’t want to be worrying about that anymore.

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Dan B August 10, 2011 at 2:28 pm

Or need I drag out the quotes by LC principals 6-7 months ago who stated right here on this blog that a +/- 6%+ return was well within the norm long term

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Dan B August 10, 2011 at 2:31 pm

I can certainly relate to that Ken.

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Peter Renton August 10, 2011 at 9:16 pm

@Dan, I know it is a little off-topic but I have to disagree again that putting significant money in one individual stock is an extremely high risk way to invest. Ten years ago people could have put their life savings into General Motors stock and think they had a great stock for the long term. My point is that you simply cannot know which companies will be industry leaders in 10 or 20 years – let alone whether a company will still be in business. I am not arguing for mutual funds, but a basket of stocks is simply a less risky way to invest. I don’t want to have a significant investment that can be destroyed by the poor decisions of a greedy CEO.

@Ken, I also like the fact that with p2p lending you are not exposed to potential stock market crashes. While you will never be able to achieve a home run with p2p lending like you can with an individual stock (such as buying Apple circa 2001), consistently good returns are achievable. And with some extra effort, like you, I believe that great returns are certainly possible.

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Dan B August 10, 2011 at 10:08 pm

Peter…………..And I would contend that even with the most brilliant note picking known to man, you could still lose every dime you invested in p2p due to the same greed or incompetence you cited in reference to GM.

In fact, even without greed & incompetence very bad things can still happen here. The ugly & unfortunate truth is that until a p2p company goes under & there is a definitive ruling on how these notes are treated…………… none of us can be certain how risky p2p investing really is. Anyone who doesn’t understand why that is unquestionably the reality should probably stay out of this investment.

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Charlie H August 10, 2011 at 10:22 pm

If you pick 10 stocks with a history of paying consistant and growing dividens you are going to do well in the long run. Dividens are currently very tax effient. Yields of 3-6% are very obtainable. T, MMM, KMP, COP, LMT, INTC just to name a few.

P2P is not a replacement for equities.

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Dan B August 10, 2011 at 11:18 pm

All I’m saying is this………..Everyone here thinks they’re going to end up with 9%-12% with p2p, maybe even higher. 5-10 yrs from now you’re going to be able to count on one hand the number of people here who ended up achieving those numbers. The majority of p2p investors everywhere are going to end up with numbers lower to much lower than those targets.

So my contention was that with a 6.2% yield, a buy it & forget it stock like AT&T is almost certainly going to do as well & very likely beat your “average” real world 6-7% p2p return over any 5yr or longer time frame. Even if the stock price were to appreciate on average by 2% a year, that’s over 8% total return per annum. I can’t imagine why this is so contentious of a statement.

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Peter Renton August 11, 2011 at 5:32 am

@Dan, It is contentious because what you are saying is extremely high risk. In my opinion I would even say putting $100,000 in p2p lending is even less risky than putting $100,000 into a single stock like AT&T. A couple of bad decisions and the dividend could be cut by 75% and the stock could half in value, and your $100K yielding 6% has just become $50K yielding 4%.

Sure you could argue there is also high risk in p2p lending. But, particularly in Lending Club’s case with $35 million in the bank and rapid growth, I would argue the risk is actually less than holding a single equity. That is my opinion and it is clear that you have a different opinion which is fine.

@Charlie, Having said all that, I still believe a basket of equities should be part of every investor’s portfolio. My stock portfolio is far larger than my p2p lending portfolio and will remain that way probably for a long time. But my new investment money is going into p2p lending rather than equities.

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gharkness August 11, 2011 at 5:54 am

Just substitute the name “Enron” for “AT&T” and your argument makes itself, Peter.

I am not sure why all the negativity. If one doesn’t want to participate in p2p lending, then there are plenty of other outlets. I certainly don’t believe in wearing blinders, but the stock market isn’t doing a great job of creating returns. Even *if* the p2p market returns something less than 6% (which i believe is unlikely for me given my personal risk profile, but I could be wrong), it is vastly better than the 1% I am getting in CD’s these days. I can hardly wait for them to mature so I can cash them in and put them to better work.

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gharkness August 11, 2011 at 5:57 am

BTW, I consider this a great time to invest in stocks, because people tend to get mixed up with the standard “buy low, sell high” advice. For some reason (panic, I believe) they tend to turn it around and buy and sell at the wrong times. It’s good for those with cooler heads, though.

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Peter Renton August 11, 2011 at 6:05 am

@gharkness, Enron is another great example of a blue chip market leader getting greedy and making boneheaded decisions that hit tens of thousands of investors. There are plenty of other examples: Washington Mutual, Bear Stearns and Lehman Brothers all basically wiped out investors. These were all blue chip market leaders just a couple of years before their demise.

I think Dan’s argument isn’t against p2p lending, it is against the high expectations many people have when they get into p2p lending. The average real world returns are less than is stated by both Lending Club and Prosper.

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Dan B August 11, 2011 at 6:24 am

Gharkness………..The fact that you’re considering moving CD money to p2p is in itself a sign that you may want to FULLY re-explore the risks inherent in p2p.

Peter………Don’t confuse bank stocks with this. Companies like AT&T & Verizon are really semi-monopolies. From these levels if AT&T stock goes down by 50%, I can almost guarantee you that we would be in an outright depression. And in that scenario p2p returns would be heavily negative & liquidity without a severe discount would be non-existent……………assuming that the companies would even be around at all.

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gharkness August 11, 2011 at 6:30 am

Dan, I am sorry: please direct your negative attitude elsewhere. I did not indicate in any way – and I do not intend – that I will invest my CD money in p2p. Believe it or not, I too have a strategy. I just didn’t – and won’t – explain it in detail here.

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Dan B August 11, 2011 at 6:41 am

Gharkness………… ” Even *if* the p2p market returns something less than 6% (which i believe is unlikely for me given my personal risk profile, but I could be wrong), it is vastly better than the 1% I am getting in CD’s these days. I can hardly wait for them to mature so I can cash them in and put them to better work.

My apologies. I thought for sure that when you said the above you meant that you couldn’t wait to move the money from CDs to p2p. I guess it was just my overactive imagination.

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gharkness August 11, 2011 at 6:45 am

OK, I see where you would think that, Dan. Often what goes on in my mind when I type isn’t necessarily what shows up on the screen :-) I see now that even if you take separately the two sentences 1) what I am getting in p2p is going to be better than CD’s and 2) can’t wait to get my money out of CD’s to put to better use, well, it still sounds like I am going to dump my CD money into P2P, but that isn’t what I really meant.

My bad, and sorry!

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Dan B August 11, 2011 at 6:50 am

No problem at all. I’ve done the same thing more than a few times.

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Peter Renton August 11, 2011 at 1:05 pm

@Dan, I am not going to argue about the merits of AT&T here because it is a good stock and you may well be right. But I wouldn’t like to put any significant money in an industry that is going to see more change in the next 10 years than it has seen in the last 100 years. That’s my 2c.

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Roy S August 11, 2011 at 2:50 pm

I’m new to p2p lending (began late January of this year) and even newer to this blog (only been reading it for two weeks). Given the early problems with p2p lending, I have only been inching in, and I now have about $3,500 invested (I’m a small-time investor to begin with, so $3,500 is more to me than probably most on this board). But I feel I should weigh in on this topic and the comments on this topic.

First, as noted in another comment, when the market goes down more people should be buying stocks as I have been doing, using dollar-cost averaging, of course. In a rational world, I would expect more people to be shying away from p2p lending in hopes of being able to buy low and then sell high. I agree that panic and a general lack of rational thinking leads to people buying high and selling low. Maybe for the casual investor it might seem as a safer alternative to the stock market during times like these, so I can see how (if there is more awareness of this investment option) more people may decide to reallocate some of their investments into p2p lending.

My second comment is more of reply to Dan B. I think you’re looking at the microcosm of p2p lending rather than looking at the larger universe of unsecured loans. Prosper and LC are both relatively new to the industry as a whole, and I believe that they are still navigating the playing field and developing better models to improve returns. Expecting them to enter the market with the same models that financial institutions, who have been developing their formulas and models for decades, have would be ridiculous. My personal view is that they are doing much better than when they first started. I’ve started doing some analysis of my own of Prospers public data, but I’ve only been going back 2 years so the data is still fairly limited, but I think they have been doing a much better job of lowering the number of defaults.

But above and beyond that, I think it is important to note both that p2p lending and the stock market are more gambling than investing and diversification is key–both between different types of investment (i.e. stocks, bonds, CD’s, etc) and within the different types of investments (i.e. from junk bonds all the way to AAA bonds and small cap stocks to blue chip stocks). p2p lending is just one avenue of investing your assets to seek a return. And just because a company is a “semi-monopoly” doesn’t mean it isn’t immune to bad management or bad decisions and ultimately bankruptcy.

It isn’t a matter of whether $100,000 is safer all in AT&T stock or p2p lending. It is simply that neither “strategy” is a good idea if that is your entire investment portfolio. If you consider p2p lending a higher risk investment than purchasing stocks, then adjust your portfolio appropriately. Will the average return end up being double-digits or will it be barely positive with p2p lending, who knows? That’s the gambling part. It’s the same thing with the stock market, though. It comes down to DD and (I hate to say it, but) luck. I am taking the risk that p2p lending will become another viable investment option and that the returns will be worth the risk (and hopefully at least be positive over the long term). p2p lending is still relatively very young industry, and I believe we will still be witnessing the industry evolve over the next few years. Further, I believe that the returns will become more stable as Prosper and LC improve their models. But only time will tell…

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Charlie H August 11, 2011 at 3:56 pm

This is more portfolio theory then anything…

You would not put 100K into just one stock. You would put 10K into 10 stocks all in diferent sectors. Some cyclical, some secular. This would be the equity portion of your portfolio and seperate from the bond, real estate, or “other” asset class part of your portfolio.

The difference between an Enron / World Com / Waste Management is that they had shakey history on the dividens front. A company that pays dvidens and consistantly raises them is less likely to have an accounting scandle.

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Peter Renton August 12, 2011 at 6:59 am

@Roy, In an ideal world you would think that when the stock market goes down that people would consider buying more because stocks are now cheaper. But as you know we do not live in an ideal world and most investors are guided by fear and greed. The latest market gyrations simply remind people of 2008-09 and what can happen with a stock portfolio. These people who can’t handle this kind of volatility may throw in the towel and look elsewhere to invest their money.

The only thing I would take issue with what you said is when you characterized p2p lending and stock market investing with gambling. In gambling there are very few winners (other than the house) and I would argue that with p2p lending the vast majority of investors are earning positive returns. Even in the stock market, if you employed dollar cost averaging in say an S&P 500 index fund, over the last 10-20 years you will be enjoying positive returns. There are only a tiny minority of gamblers who can make a positive return in the long run.

@Charlie, I am also a big fan of dividend stocks, but even a strong and growing dividend is no guarantee of success. Look at GM and Wamu who both had strong dividends for decades before going belly recently.

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Roy S August 12, 2011 at 2:15 pm

@Peter, I would disagree with you. Just because there are more people making a positive return doesn’t mean that the two aren’t comparable. I would even equate starting a business with gambling, putting your money in a savings account, and even insurance. You are still taking a risk for a potential reward, and you are still wagering your money on an uncertain outcome. In Vegas the odds are less in favor of the gambler and so you are taking a greater risk. But at the same time, the rewards can be much greater, too. Different people have different tolerances (my tolerance is that any money gambled would be purely for my own entertainment) when going to Vegas so each individual may have a different return on their “investment.” They may choose slots or black jack. They may even have a strategy (e.g. card counting).

The idea that there are still people who are making a negative return in the stock market and p2p lending (and that it is possible to have a negative return in the first place) is what necessarily makes it gambling. It is just on a smaller scale with smaller risks and smaller gains and losses. Even having the majority enjoying positive returns overall does not negate the fact that this is, at its most basic form, gambling.

I think the issue that you take with my calling it gambling is that the general connotation of gambling is associated with casinos (with everybody making a bet against the house) and the great amount of luck involved with winning rather than a rational approach and strategy to increase your odds and returns. For you, it may be pure luck. For those with a strategy and rational approach, there can be a positive return.

With the stock market, you may have a strategy and rational approach where you can make a positive return. On the other hand, as you’ve already conceded “most investors are guided by fear and greed.” There is no strategy on their part, and the loss of their money is quite high. Every time you buy, you are making a bet the stock will go up. Every time you sell, you are betting the stock will go down (in this way it is more akin to poker where you’re betting against others than to blackjack where you’re betting against the dealer/house). You and I may make a profit on the stock market, they may end up with a loss. But I really doubt they were going in trying to make a loss. If they were, then I would agree with you that it is not gambling.

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Peter Renton August 12, 2011 at 8:29 pm

@Roy, I can see that you take a very broad definition of the term gambling, so I would agree based on your definition that pretty much all investing (outside of maybe treasuries or FDIC insured deposits) is some form of gambling. But p2p lending is a gamble I am comfortable putting a good sized chunk of money into; that same amount I would never consider putting into more traditional gambling such as poker or blackjack.

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