For the past six months, I’ve been lending money—$25 at a time—to perfect strangers. In exchange, I’m on track to earn a 12% annual return on my investment.
No, I’m not a loan shark; I’m a Lending Club investor.
Person-to-person lending is coming of age. Since I first experienced it when I took out a Prosper loan in 2006, I have realized some things are clear: Social lending is not a scam, and, IMHO, it’s more than a mere fad.
Lending Club currently has over 11,500 funded loans in the last two years and just expanded by announcing it will offer 5-year loans in addition to its original 3-year terms. As you can see in the image below, their aggregate returns are impressive.
So is it time to add social lending to your investment portfolio?
I’m a believer in social lending because it takes lending decisions and profits away from big banks and gives them to ordinary people.
On the other hand, there are vocal critics of social lending that say the trend is a microcosm of our broken financial system, not a solution to it. In the event of investors giving somebody who is already maxed-out an unsecured $20,000 loan at a 22% APR, I would agree.
But social lending has the ability to do much better. Peer-to-peer business loans can fund start-ups banks won’t. Peer-to-peer personal loans can give good people an honest way to clean up credit card debt. Peer-to-peer auto loans provide an alternative to dealer financing. And instead of banks getting the profits from these loans, ordinary people get them.
Lending money will always be risky. Some borrowers will always default. The key, as any investor should know, is diversification.
If you fund only high-risk, high-return loans chasing 15, 18, or 20 percent annual returns, you may lose money. But if you take a conservative, balanced approach to social investing and spread your investment out over dozens or hundreds of loans, I believe this kind of investing has a place in a savvy investor’s financial plan.
Is becoming a Lending Club investor right for you? I would say yes, if:
- You’re Diversified. You’re already investing in stocks or mutual funds.
- You Start Slow. You start investing with a small percentage of your money and invest conservatively.
- You Can Afford It. Basically, I would treat investing in social lending as riskier than it may actually be. So, for now, don’t invest what you can’t afford to lose.
And if you’re in place where you’ve already maxed out your 401(k) and/or IRA and have money left over to invest, I think you could really make some headway on your investing goals with Lending Club as a bigger part of your portfolio.
Until then, if you want to give Lending Club a try, it only takes $25 to start investing, and you can even create a no-fee IRA.
If you’re interested in learning more about Lending Club loans, read about person-to-person personal loans.