My Personal Finance Journey

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What's Next for My Micro Lending Endeavor?

Contributed by mm | July 30, 2006 8:12 AM PST

Recently I shared a lot about my experience at Prosper.com by making micro persona loans ("After 100 Personal Loans ...", "Is Micro Personal Lending Worth the Trouble?"). With more than $9,000 invested in over 100 personal loans, it is time to reflect and decide on what I should do next with my lending experience.

First, let me say I am a huge believer of the business model of person-to-person social lending. Successful execution of this business model will remove a lot of friction cost in the banking (in which banks draw deposit from savers and grant loans to borrowers), and let both lenders and borrows benefit from such improved efficiency in the banking transactions.

Second, Prosper is executing the model quite well so far with enough participants on both side to form an efficient market. According to my tabulation, Prosper as a marketplace is on track to close 600 loans in the month of July, showing enough momentum compared to about 500 loans closed in June.

On the flip side, the success of the marketplace is still to be tested by time. All Prosper loans are 3-year installment loans, which means it will take at least two more years for lenders to fully access the true profitability of existing portfolio. In addition, jury is still out with regard to whether the current process is enough to curtail unavoidable scams within an acceptable level.

For me personally, if I keep investing at the current speed, I will have about 30 grand invested by the end of the year -- it might be on the heavy side compared to my full portfolio size (expected to break the half-a-million mark before then). I am usually not a risk taker, and it will be a stretch for me to commit such a big pool of money before I fully understand the nature of the investment.

On top of that, the daily 15-minute round I put toward finding new loan requests is becoming a chore at an expected yield of $26 an hour. Starting from two years ago, I have been seeking a balance between money and work/life balance ("The Cost of Being Frugal"), and $26/hour is perhaps not a job I want to take in addition to my busy working schedule forever.

So, I plan to get less aggressive in lending out money in the next few months, with a target of $12,500 invested principal by the end of September. As time goes by, I will also monitor the performance of my existing loan portfolio, and better form my risk assessment of Prosper loans. (Can I say 100+ loans represents enough diversification and sample size?)

Summer is not entirely over. With some new found time, I can bring my family for one or two more vacations!

This Post Has Received 6 Comments. Share Your Opinions Too.


David Hamm Commented on July 31, 2006

To decrease the amount of time you spend on setting up a loan why not just increase the amount per loan. You say this increases risk but it doesn't change your expected return. In fact it'll increase your expected return if you factor in the time savings. I'd keep the total number of loans constant and increase the amount of each loan. That way you'll still have a diversification but you won't have to invest as much time.


Mike O. Commented on July 31, 2006

You mention the solution right in your own comments, at your current investment rate you will put a larger percentage of your portfolio into this than you are comfortable with.
Slow down! :-)
Once your money is invested there, there isn't much more to do. It's just the slow process of getting through all the initial bids. I am hoping that soon all the money I transferred to Prosper will be in active loans, but it has taken a few weeks.


makingourway Commented on August 2, 2006

mm,
David Hamm actually has a really good idea. The Law of Large Numbers indicates that once you have a sufficiently large number of investments (or insurance policies - it's an insurance term), you'll have enough risk distribution.
The question really is how many borrowers do you really need to achieve sufficient risk distribution.
To a certain degree, I believe it depends upon the your target credit market - what's your target credit grade?
Once you know that you can reference the likely rate of default and then factor it in against the average loan versus number of loans. Now I'm not a math person, so someone smarter than me has to figure this out. But I assume once you know the statistically average number of defaults and amount of default (assume perhaps 30% of payments made before default) you can will understand the probable loss of interest payments. Then you'd raise your interest rate to offset (and possibly increase the number of borrowers).

My gut says my target would be $200 per loan with about 100 - 200 loans. It would increase my pay per hour, but not by much.

Ultimately, I think $500 per loan over 200 loans might have a pretty decent return per hour. I'm not sure what the target interest rate and risk profile would be.

Hmmm...anyone feel motivated to create an on-line spreadsheet?

Regards,
makingourway


MM Commented on August 2, 2006

Yes, doubling the average principal per loan will double my payout per hour, but my main concern is whether I have a good handle of the risk now. That's why I feel I need to pull back, allow the oustanding loans to age and get more understanding before I double up my bet.


makingourway Commented on September 3, 2006

mm,
Good point about letting them age.
I'm moving more conservatively into prosper, putting about $500 per month into it.
A financial advisor I talked with considered prosper.com more like gambling due to the unsecured nature of the loans, etc....
However, if you successfully diversify, it shouldn't be any riskier than junk bonds (which he avoids as well).
regards,
makingourway


john Commented on November 11, 2006

A financial advisor told you Prosper is like gambling?! Big shock, let me guess, they probably told you that you should buy some mutual funds instead....and that they could help you set up a portfolio!

Of course these loans are risky, they are unsecured with the exception of the person's credit rating. But that's why you can get 25% returns! Everything out there is a risk reward tradeoff, otherwise economics says the opportunity to make a risk free profit will dissapear (i.e. become immigrant direct's interest rate)


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