For the past month or so, I’ve been performing a bit of an experiment. I’ve been taking 10% of all income from this and my other sites and splitting it between an investment account and my Lending Club portfolio. The idea, of course, is to see which performs better.
In order to do that, I needed to find a good way to calculate what the real rate of return to me is. Here’s the formula I settled on.
(1- (Total Deposits / ((Total Deposits + (Total Interest Received – Fees Paid))*.97)))
I should qualify the rest of this by saying that I’m not the best at math, so there may be flaws here. Feel free to let me know in the comments. Also, if there’s a better way to go about this, please let me know in the comments as well.
So, let’s break that down a bit. The *.97 part is meant to give some accounting for inflation. It takes 3% right off the top as an inflationary cost. Is 3% enough? That’s debatable, but it seems like a fair average, historically. This bit: (Total Interest Received – Fees Paid) is merely the total income on the portfolio. I’m missing a small bit here, as the cost of the principle is not equal to the actual principle of the portfolio. That’s because I live in a state where Lending Club doesn’t have the right permissions to allow me to directly invest in the loans. So, I’m having to go through their foliofn note trading platform to buy my notes and there is usually a small premium on the notes. I haven’t decided on a good way to really include that in, or if it really should be. The next bit, (Total Deposits / ((Total Deposits + that previous bit is basically determining the % growth. Total deposits divided by current “balance”. The 1- part at the beginning just gives the cleaned up decimal percentage.
Let’s walk some numbers through it. We’ll use these:
Total Deposits = $1000
Total Interest Received = $25
Fees Paid = $5
So, plugging those numbers in we get: (1-(1000/((1000+(25-5))*.97)))
We’ll do this old school and solve as we go, showing our work. Parenthesis get priority, followed by addition and subtraction. So, we next end up with (1-(1000/(1020*.97))). Then, we end up with (1-(1000/989.4)). Next step, 1-1.011 = -.011. So, we get a return of -1.1%.
Seems logical right? In the case of my portfolio, the result comes back as 10%. That’s a pretty good number, if you ask me. I haven’t had any defaults yet, and I’ve had loans in my portfolio since January of 2010. (the experiment I talked about earlier only began in July, however, but previous portfolio is included for easy of calculations)
I’m sure there’s some much more complicated formula that would take in risk of default on remaining invested principle, and a way to get the most accurate number, but really, I’m not sure that I want to take it that far. This will never get to the point, I don’t think, of having a majority of my overall portfolio in it. It’s not nearly safe enough for that, and my retirement accounts will remain in more traditional markets.
But, with results like 10%, and the current state of the stock market, one has to begin to wonder if the stock market is the safer of the two markets. The stock market certainly isn’t showing returns of 10% recently.
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This is the second article about lending clubs I’ve read in the last week. I had no idea they were getting so popular. The other blog “Brave New Life” said he hoped to get a return of between 12-15% overall. That is outstanding if it actually works. I don’t have the capital yet to look into this “asset class” (can it be defined as an “asset class” all to its own?), but I am very interested for the long term.
Anytime you “cut out the middle man,” it makes perfect sense to me. Will you limit your p2p lending to Lending Club OR would you consider lending to friends as well?
@My University Money: It doesn’t take much to get started on lending club. The minimum investment is $25 if you’re investing directly. If you’re buying through the marketplace, like I have to, you can get notes for as little as $10.
@funancials: I specifically don’t lend to friends. With Lending Club I can keep emotions out of it. With friends, it becomes much more “interesting”, so I avoid it.
I would recommend you use compound annual growth rate:
((price today / price paid)^(1/# of years invested)) -1
That is how I’m tracking my Lending Club returns and also my permanent portfolio returns. The difference is that it takes into account the duration of the investment, which yours doesn’t. That’s if you care, of course.
nice returns.. certainly better than my savings account. definitely starting one once I have enough in my play money fund.
@brave New Life I’m not sure I understand the formula you give. Is that meant to replace a part of the formula I have? I’m not exactly mathematically inclined, in case you hadn’t noticed. 😉
How much time does it take to invest intelligently here? It seems that this is a form of venture capital investing – which historically has been pretty much limited to ‘qualified’ investors.
@Marie I think that depends wholly on how much analysis you want to put into it. I recently posted a post on how I select investments here: https://www.beatingbroke.com/lending-club-selecting-investments/ For me, that method keeps it down to about 15 minutes per investment. Not much time for some pretty decent returns.
Why bother with the inflation part. If you are comparing 2 items, they both will be hit with the same inflation rate.
@evan, It probably isn’t necessary. Like I mentioned, math, especially investing math, isn’t my strong suit. I like to do things conservatively so included it.
I haven’t gotten involved in lending clubs, yet, but it does seem like an interesting alternative investment! I’d like to take more time to learn more about them at some point.