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About a year ago, I wrote a blog called "Show Me the Money: Six Strategies to Put Your Cash to Work," where I talked about two new(ish) investment strategies my wife and I were using. I wrote a followup blog about the first strategy, Electronically Traded Funds (ETFs), where I compared Betterment vs. Wealthfront. Now here is a followup on the second newish strategy that you're probably not yet trying out, but absolutely should be: Peer to Peer lending... or put another way: Lending money to complete strangers as an investment strategy.
I'm going to write this blog as a step-by-step how-to guide on trying P2P lending. Don't think you have enough money to become an investor? Wrong. Just set aside $25 to invest in each of the 2 biggest platforms. Seriously, who can't part with $50 to try something that will change your perspective on lending?
First, more on what P2P lending is:
OK, what's the catch?
Just like anything in life, there's are risks to P2P lending. It's important that you really understand what they are. I'm going to walk through each risk that I consider significant, and how to protect yourself against that risk.
Starting small: The ideal minimum investment size
OK so let's say you're like me and my wife -- you want to start small and see what it's like to put your dollars to work on a P2P platform. What's the minimum you should put to work? Like I said above, you can literally get started with $25 on each platform. So if you're debating between doing nothing vs. trying it, then literally just fund each account with $25, and fund two individual notes (the minimum investment size is $25 per note you fund). That's not the ideal minimum, however, and here's why: You want to diversify your risk across many borrowers, so if one defaults, it doesn't torpedo your returns. If you only invest $25 to fund one borrower, and that borrower defaults, then your return will be shot. There's a great article by LendingRobot that shows once you invest in at least 146 notes at $25 each, you have a statistically minuscule chance of earning a negative return. LendingMemo takes it a step further and breaks the diversification recommendations down by your risk tolerance -- they suggest funding a minimum of 200 to 300 loans (depending on the note's risk scoring grade level) at $25 each so you can get an expected positive return. 200 notes x $25 invested in each = $5,000. And there's another reason to start at a $5k investment level, as I'll describe below. So, to reiterate: Start with $50 just to experience it. But if you're really going to make this a part of our investment portfolio, invest at least $5k.
(A side note about what "investing $25 in a note" really means: Let's say a borrower -- we'll call her Sally -- wants to borrow $10,000 to consolidate her credit card debt. She goes to LendingClub and applies for a loan. LendingClub will take that $10,000 loan and break it up into smaller chunks, and then offer each chunk to individual investors. So for example, Sally's $10,000 loan might be funded by 400 investors at $25 each. This diversifies the risk for everyone. If Sally defaults, those investors each only lose $25 -- a small part of their overall portfolio).
Sue and I use P2P lending for an aggressive part of our portfolio. Although we could choose to fund "A1" grade loans, we want to achieve a return of at least 10% annually, so we tend to fund D,E & F grade notes. In fact, as you can see in this screenshot below, LendingClub has over-allocated us on A,B & C grade notes, and can't fill our demand for the lower grade notes. This is typical because most investors who are putting money to work in P2P platforms want that higher return and are willing to accept the higher risk that comes with it.
But even in this under-allocated state, we are achieving a net annualized return of 11.89% -- and that's after accounting for defaults & charge offs! Here's what I mean: By investing in lower grade notes, we are expecting that a higher percentage of those borrowers will default on their loans, and subsequently, have their loans charged off. But that's why the interest rate on these notes is higher -- to account for the expected charge offs. LendingClub has issued over $9 billion in loans since it started. You can see from this chart that the charge off rate on all loans is 3.6%. When you diversify your portfolio by spreading $25 investments over thousands of notes, you're able to control for the variables that would otherwise be really scary, like "what if someone defaults?!" At these large scales, it all becomes a math equation: How much risk are you willing to shoulder in exchange for what level of projected return net of that risk, and then set your investing criteria accordingly.
And just like a bank or a credit card, if a borrow goes late, the lending platform will try to collect on the loan. For example, here's an actual default from our portfolio. You can see this borrower got a $12,925 loan from LendingClub. We pitched in $25 to fund that note. They stopped paying, and for 3 months, LendingClub tried to collect. They eventually charged the loan off, which negatively affected the borrower's credit score. We lost our $25 -- but not without a fight! And LendingClub did all the actual "fighting". (You can see a larger version of the screenshot here.)
Another reason to invest at least $5,000 is that once you do, LendingClub will turn on a feature they call "Automated Investing." If you invest less than $5,000, you have to slog through each available individual note, deciding which to fund. When you put $5k into their platform, they'll handle all the investment decisions for you based on the criteria you set, so it literally becomes a "set it and forget it" experience.
OK that's it for the "P2P Investing 101" part -- I encourage you to give it a try. Start with just $50 to experience it. Give it a solid try with $5k. Or get adventurous if you have the cash: Putting $120k to work on the platform will earn you $1,000/mo in interest income at a 10% return. (Important tax note: This income is taxed at an ordinary income rate, not a long-term capital gains rate, which reduces your net return... talk to your tax advisor, because I am certainly certainly not one!)
But wait, there's more -- here's the best part if you want to go deeper:
For the past year, Sue and I have been using LendingClub's "automated investing" function and happily earning an 11.89% return. But it was driving me crazy that we were under allocated in the notes we most wanted to get into. So I did some digging. It appears that we're not the only ones that have this idea. Hedge funds and other institutional investors have been using an API access layer to snap up notes the second they hit the market -- indeed, faster than even LendingClub's automated investing can pick them up. I wanted in on the API action! So I turned to a service called LendingRobot which hooks into both LendingClub and Prosper through the API interface. I've just recently begun experimenting with it, but the interface looks awesome. For example, I created two "rules" which define how we want to invest our cash in LendingClub. For example, one of our roles is to only invest in notes with a 14%+ expected return, and to borrowers not in FL, AZ, CA or NV (here's why). LendingRobot projects we'll make a 15% ± 7.44% return with these filters.
The second rule is for borrowers who have a mortgage (no renters, no outright homeowners) with zero inquiries on their credit reports in the past 6 months (here's why) with a 12%+ expected return. LendingRobot projects we'll make a 13% ± 6.56% return with these filters.
The downside of using LendingRobot is that they charge a 0.45% fee for providing this lightning fast API access and filtering capabilities, which has the net effect of reducing our overall return by that amount. It's too early to say whether the value created LendingRobot will offset that additional fee, but I'm willing to give it a try. For now, I've kept "Automated Investing" turned on in LendingClub while at the same time letting LendingRobot have access to the cash in our LC account. I figure if their API really is faster, they'll get access to that cash first, and if it's not, they won't. I'll report back after a few months to let you know how the LendingRobot returns are comparing against the straight LendingClub returns -- and I'd LOVE to hear any feedback from anyone who has experience using LendingRobot or any of the other automated investing P2P services springing up out there.
I hop you give P2P lending a shot-- and welcome to the sharing economy! Please leave a comment below describing your experience if you do try it.
I'm going to share a story about the forest vs. the trees. But it's not the story you're expecting to hear.
My last blog post was about Doing Less, Better, which is my theme for 2015.
A big part of doing less, better is achieving focus. But that very word is often misunderstood. Focus means the elimination of distractions, not the mitigation of distractions. Let's dig into that more deeply:
The first hard thing in a startup is knowing what to focus on initially. When you first start, you don't have strong product/market fit in anything, so like any good LeanStartup you might start with a hypothesis and work through the build --> measure --> learn cycle as quickly and effectively as you can. The key is to find some early area of traction & demand that you can build off of.
There's a great article in the NYTimes about Slack, a new startup that the Valley is buzzing about. Slack is a business messaging & collaboration app, and it's really, really good. The reporter in the article questions whether this year-old company is really worth $2.8 billion.
Slack is not good because it has a ton of features. In fact, it's missing the things that I would expect it to have.
It's good -- and worth its valuation-- because it does less, better.
The things Slack chooses to do, it does insanely well.
This new startup, Jet.com, is looking to be the Costco of the web, and to undercut Amazon's prices by an average of 10%. They won't focus on speedy 2 day "prime" delivery. Instead, by being a member and paying a $49 annual fee (like you do with Amazon or with Costco), you'll get access to discounts, but the products will take longer to ship to you. This is a great model for non-time-sensitive things, like re-ordering diapers.
But the best part of it is how they're building a pre-launch interest list: When you sign up, they give you a unique sharing code. For example, mine is https://jet.com/#/ji/cj2tx and I'm currently member 124,837 of 124,877 on their interest list. The more people sign up based on your code, the more rewards you unlock. That's not all that new or innovative -- but the part that's great is that they're offering lifetime memberships and even stock options to their top sharers. Which is a great marketing move, although the reality is that getting 100k options doesn't mean much unless you know how many total shares are issued, and what the strike price is. But it's marketing genius!
At a recent DFJ venture capital conference, I heard the story of Arash Bayatmakou.
He fell from a 3rd story balcony a few years ago and landed on his neck, paralyzing him from the chest down.
Incredibly, he's determined to walk again. We exchanged emails after the conference and he signed off with this:
A high five, coming from a guy who's facing incredible challenges every day just to get back to doing the things we take for granted. I loved it, and decided that from now on, I'm going to sign my emails with a high five as well, as a tribute to him and his positive attitude.
Time is our most precious asset, and none of us know how much of it we have left.
It's ironic, then, how easily we let it slip away. An hour for a meeting, an hour in traffic.
Next time you get asked to spend an hour doing something, just hold it up to this filter before you decide:
I'm going to share one of my most powerful negotiating techniques. The funny thing is that up until a year ago, I didn't even realize this was a technique -- I thought everyone did this. But apparently not -- here's the backstory:
But before we get started, remember what Spiderman was told: "With Great Power Comes Great Responsibility." The technique I'm going to share with you can be abused, and when it is, you'll come off as a total jerk. That might be fine if that's what you're going for. But make sure you focus on using it responsibly. More on that at the end.
I absolutely love this video of Zuck talking about Facebook back in 2005. If I had been in that room, I wouldn't have been able to guess that Facebook would become a $180+ billion company.
The best part: Zuck describes Facebook in minute 1 as an "online directory for colleges." Not only does that not like a billion dollar business, but it also sounds like a terrible startup idea.
The lesson: The key nugget is "I launched it in Harvard in early Feb 2004, and within a couple of weeks, 2/3 of the school had signed up". That is an incredibly strong signal that there's a really good initial product/market fit. This is a recurring theme that also permeated Y Combinator's recent Startup School, which talks about the importance of finding product/market fit above all else.
The kicker: I love how, in minute 3:55 Zuck is asked "And where are you taking Facebook?" He responds with "I mean, there doesn't necessarily have to be more."
The richest 1% of Americans have access to great financial tools and advice: Firms like Goldman Sachs provide them with (legal) tricks like Tax Loss Harvesting (TLH). Never heard of TLH? Neither had I until my buddy Andrew Dumas, after reading my post titled "Show Me The Money: Six Strategies to Put Your Cash to Work," mentioned a new startup called Weathfront that was on the cutting edge of ETF fund-based portfolio management. This opened a whole new world of investing up to me, which I'd like to share with you.
But first some background: In my past blog post I talked about ETFs, or Exchange Traded Funds, which are a class of funds that create a basket of stocks based on a particular segment of the market. For example, in the past if you wanted to invest in technology companies you basically had two options: You could pick the companies you thought would be the winners, like Google and Yahoo and buy stock in those directly, or you could invest in a mutual fund that has an expert who picks the companies, and you'd pay a management fee for his or her expertise. But ETFs offer a third choice, and it's worth really understanding how they work. Here's a description from Wikipedia:
"ETFs generally provide the easy diversification, low expense ratios, and tax efficiency of index funds, while still maintaining all the features of ordinary stock, such as limit orders, short selling, and options. Because ETFs can be economically acquired, held, and disposed of, some investors invest in ETF shares as a long-term investment for asset allocation purposes, while other investors trade ETF shares frequently to implement market timing investment strategies. Among the advantages of ETFs are the following:
I'm the SVP of Strategic Partnerships at ShareThis. It's my job to find the right strategic partners for us to work with. This morning, in the shower, I thought "I'd like to have a simple combo slide deck + narrated screencast to show to prospective partners."
So, I just finished hacking together a simple site that explains our business. It's something I did in just under an hour using a combination of HTML, Google App Engine, Google Slides, HelloBar, Vimeo, iShowU, Google Labs' ShortLinks and AdRoll. It was fun to make it and I expect it'll prove useful.
That activity, of taking an idea I had in the shower this morning and hacking it together in an hour today, got me thinking about the difference between makers and managers, and about how few managers really appreciate (or are able to participate in) the creation process -- especially when it involves some amount of hacking.
I find that managers who are also makers have an ability to key in on opportunities that non-maker managers miss. They have a better ability to connect with their teams. They can go a level deeper into projects than non-maker managers. They can ask more intelligent questions. They can conceptualize and create efficient processes much more quickly and easily. Or to put it another way, they can be much better managers by also being makers.