Beating Broke

Personal Finance from the Broke Perspective

Calculating a Real Rate of Return on My Lending Club Portfolio

By 14 Comments

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.

Golden Guy Balancing RiskSo, 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.

photo credit: lumaxart

Street Smarts

By 7 Comments

Street Smarts: Beyond the Diploma
By: Jim Randel

Often, when we’ve “grown up” and graduated college, we all move on to our new lives as adults with the expectation that our schooling has given us everything we’ll need to be prepared for the wide world ahead of us.  And, just as often, we are disappointed.  While school has the advantage of preparing us for the work part of the world; we can all read, write, and do most arithmetic; we are usually very unprepared for the subtle nuances that take place that will give us a step up on the ladder of success.

Jim Randel, if you’re unfamiliar with him, is the author of the Skinny On series.  I’ve reviewed a few of those here before, which, I would guess, is why his company sent me a copy of this book.  (That’s my disclosure, folks.  I was sent a free copy of the book.)  What he’s done with both the Skinny On series and this new book, Street Smarts, is to take some very complex issues, and simplify them enough that you can get the basics without having to knock your head against the wall trying to understand them.  Street Smarts holds 125 lessons on how to better succeed in the real world.  Each lesson is short, to the point, and valuable.  There’s very little chaff to sort through, and it’s an easy and fast read with some rereading value.

One thing you won’t find inside it’s pages is explicit detail.  There is not, for instance, 20 pages on the mathematics behind the rule of 72.  There also is not 100 pages or more on the workings of a mortgage loan.  Each is it’s own lesson, and is two pages.  You’re not going to learn everything there is to know about any of the topics by reading this book.  What you will get is the highlights that will allow you to safely navigate the topic without causing yourself too much trouble.

The book is also paired with a website where they’ve been putting up regular fresh content.  It’s already got quite the archives of good tips and information.  You can visit it at TheStreetSmartBook.com.

This book would make a great gift for a newly graduated senior, of high school or college.

Opportunity Cost is Bull

By 10 Comments

That’s right.  Bull.  All these experts go on and on about calculating the opportunity cost of something and adding that in to your cost analysis when deciding whether you should do something yourself, or hire it out.  Heck, even I have used it before.  But, we’ve all taken it way too far.

Let me ask you this; What is your opportunity cost of reading this post?  Of eating your breakfast this morning?  Not relevant?  Bull, again.  We use it to determine if we should keep cable T.V.  We use it to determine the added cost of our daily commute.  Personally, I’ve used it to validate paying people to do all sorts of things.  Mechanics?  The cost of doing it myself is too great, let them replace those brakes!  Plumbers? I hate doing plumbing.  Let them fix that leak!  We’ve become so obsessed with being frugal and pinching our pennies that we figure out the cost of everything that we do.  If the cost is too high, we should avoid doing it, or do it ourselves, our mantra goes.  But, that isn’t always true! Sometimes, it’s just straight up bull.

We all want to improve our finances.  That’s why we do those calculations.  It’s simple mathematics.  The problem with opportunity cost, however, is that most people assume a 100% efficiency.  I hate to be the one to break it to you, but there is nothing that is 100% efficient.  Not you, me, or anything ever created.  There’s gonna be some loss.  So, yes, I can figure the opportunity cost of my time.  But, it depends on my using that time to be efficiently working on something that will make me money.  The opportunity cost of my time at work is about $25/hour.  But, that doesn’t mean that every hour I sit at home watching T.V. has an opportunity cost of $25/hour.  I can’t stop watching T.V. and replace that time with paid time for work.  They don’t like paying overtime.  Plus, I’m paid on salary, so every extra hour I work at work, reduces the effective hourly pay.  Did you catch that?  Every hour over 40 hours a week that I work reduces my efficiency to earn money.  If I were paid hourly, that might be slightly different.  But, I’d be willing to bet, my employer would still have an aversion to paying overtime and would not allow me to work many more hours over 40.

If you’ve got side projects, like I do, there is a opportunity cost for every hour that I’m not working on them.  Some side projects are extremely easy to figure the cost of.  If I contract out my work on an hourly basis, my cost (for every hour I’m not working that project) is that hourly rate.  But, just like my job, I can’t be 100% efficient at my side project either.  I’ve got to sleep sometime.  (Egads!!!  The opportunity cost of sleep!!!)

The point is this; If you’re going to try and figure the opportunity cost in order to validate a decision, don’t do it blindly.  Realize that you won’t be 100% efficient.  Just because you disconnect the cable T.V. doesn’t mean you’re going to replace all that T.V. watching time with efficient money making time.  Some of it might be spent reading a book.  Or playing with kids.  Or napping. 😉  Each of those may have some benefit to you, but they really don’t have much place in a financial cost analysis.  Sorry, you can’t bill your kids for playtime!

The personal finance world is full of stuff like this.  Mantras and rules-of-thumb that we use like crutches to validate and justify why we do what we do.  It’s like an addiction.  If you truly want to take control of your finances and live a better life, you’ve got to discard those addictions like you would a pack of smokes and begin to analyze what you do with a critical view.  Nothing is worth using in your finances until you’ve tested and proven that it is.

photo credit: zogh