Prosper Lending

I have been involved with peer to peer lending site Prosper for almost a year and a half. I decided to try it out as further diversification of my portfolio and because I thought the idea was interesting. For those who don't know, Prosper allows peer to peer loans to be made. Basically borrowers apply for a loan, and many lenders bid on the interest rate with a small piece of the loan. For the lenders, the rates are higher than you could get with a CD or money market, but for the borrowers lower than most credit card rates, usually in the range of 7-25%. However, with the higher interest rates come the risk of default. Typically, a lender would own many loans in the range of $25-$50 spread across a diverse set of credit ratings.

Not surprisingly, this interest rate mostly attracts borrowers who couldn't get a home equity or lower interest loan, so you know immediately these are rather risky loans. Doing a quick look at the lendingstats.com you can find a lot of statistics on current lenders. The average return on investment (ROI) for lenders with loans of >6 months is shown in the graph below:

I started with a pretty diversified investment of $3,187. Over the last year and half, I 've seen two loans default, two get paid off early, and the rest are current.

One problem with Prosper is I can’t really trust the ratings and there is a very high default rate. Virtually everyone has experienced at least one default who has loaned any sizable amount of money. The current Prosper history of all loans is shown below.

Note that 10.2% of all loans are currently 3+ months late or defaulted. Typically 3+ month late loans don't become current. Then the loans that are in really good shape, end up paying off their loan early. So you don’t make much interest off of the good loans, and you are stuck with a number of risky loans that may default. Just one or two defaults can seriously eat into your profits for the year. Last year I had about $2900 invested and ended up with net profits of $19, while my current ROI is estimated to be 7.18% for the life of the loan. Plenty of A rated loans default as well. See from my loan breakdown below that I had a diversified collection. An A and C rated loan defaulted, while a AA and D loan were paid early.

Finally, perhaps the biggest problem is there is no liquidity. There currently is no secondary market, so your money is tied up until the loan is paid off in a maximum of three years. I would consider investing on a continuous basis if I was able to pull it out when I needed. Here are a few things I've learned and suggest:

1. Don't setup any automated investing through Prosper, you can use filters, but in the end you need to do a little investigating before pulling the trigger,
2. Don't invest in any businesses: Most businesses go bankrupt and there is very little damage to the individual's credit (or motivation to pay off the loan) if they had it setup as an LLC.,
3. Fund only smaller loans, <$3,000, as there is less chance of them falling behind.
4. Research online using LendingStats and the message boards at Prospers.org.
   
   

ETFs vs. Mutual Funds

Quick list in the difference between Exchange Traded Funds (ETFs) and Mutual Funds. If you listen to talk radio financial advice, you may have come across Ric Edelman, financial planner extraordinaire, who loves to bash mutual funds (since his last book came out). He, besides endlessly promoting himself, pushes ETFs instead. However, he is making an apples to oranges comparison. His main problem with mutual funds are with actively managed funds, while ETFs are index based funds, so it is more proper to compare ETFs to index mutual funds. So if you believe in the philosophy of investing for the long term by indexing, I think both options are equally good. Main differences:

• ETFs are traded throughout the day on the stock market, Mutual Funds are only bought at the close of the market. For the long term, this is not a major issue, as you can more precisely buy and sell and ETF using limit or stop orders, however with mutual funds you need to check the index performance and decide to buy or sell just prior to market close. If you are dollar cost averaging and investing for the long term, daily market swings are unlikely to cause a major difference in performance. Slight advantage to ETFs.
• ETF transactions incur a broker commission. Index mutual funds have no transaction costs. Ultra low cost brokers do exist, so this can be somewhat mitigated, but for dollar cost averaging, ETFs will cost a little more. Slight advantage to mutual funds.
• Expense ratios for each are very low. ETFs are typically slightly lower. For example, at the moment VTI (the total stock market ETF) vs. VTSMX (the total stock market mutual fund) is .07% vs .19%. Both are very low compared to actively managed funds that can be 2% or more. To see what this means for performance, I compared the total performance of each over the last 5 years. Currently they are almost identical, VTI is up 69.5%, versus 69.7% for VTSMX. So the mutual fund actually did better. This comparison will vary based on what indexes you are using and which mutual fund product.
• Tax advantage is really none. Both should have minimal distributions, since there is low turnover, and both will generate income from dividends. Capital gains are handled the same.
• Minimum investments for ETFs are one share. Often mutual funds require a few thousand dollars to open the account and then some small amount per transaction ($50 or $100). This is an advantage for ETFs for the very small investor just starting out.
• ETFs can be shorted and Options are available, so calls and puts can be used. Mutual Funds cannot do this. So for the very active trader, ETFs are a much more sophisticated product.

While ETFs and index mutual funds are quite similar, there are some advantages to each. For the long term passive investor, either will serve you well. If you are currently invested in quality index mutual funds, there is no advantage to transferring that to ETFs. If you want ultimate control and have a very low cost broker, ETFs are probably better, but don't be scared away from mutual funds. No matter which you choose, what is ultimately important is your asset allocation, and low expenses. Research has shown those factors to far outweigh market timing techniques over the long term.

Myths about the Government Stimulus Package

I couldn't help but write a quick note to correct misinformation about the Government Stimulus Package. There has been a lot of discussions in both the media and discussion forums.

• This is not merely an advance on your 2008 tax returns. This is an actual rebate of $600 that is in addition to what you would have gotten. Yes you are getting it early, but it is additional money. Which is why it will cost an additional $170 billion to implement.
• The purpose of the stimulus package is to help the economy, not to help the individual. There is a lot of discussion about what is fair, where the cutoff should be, and who is wealthy. This is not meant to help the poor, unemployed, or middle class; it is meant to help the econonmy. Consumer spending drives the US economy, the main purpose is to pump money into retail and raise GDP. Unfortunately the Government can't do that itself, so it needs a proxy to do that, and that proxy is the consumer.
• Opinion: There is no better way to get the money in the hands of consumers than a check. Debit cards, gift cards, etc. cost more, are less secure, less liquid, and provide no real benefits. Changing tax rates such as payroll taxes favor the wealthier and is a logistical nightmare. Plus you need a lump sum amount, not a small amount over many weeks.
• Opinion: This stimulus package is good for votes, but will do little to stimulate the economy. Look for actual spending to increase slightly over the next few months, but it will not be sustained.