Friday, October 3, 2014 Review: Invest Like A Bank

Does it upset you?  Does it upset you that banks can take your money and pay you essentially nothing to hold it?  It upsets me!

Meanwhile, all the money they take from you (deposits) is quickly used to fund their lending and investing practices with the goal of turning a profit.  See, banks are businesses that have accounts (representing money) as their inventory.  They get to move all this money around.  So they'll take your deposit, give you less than 1% in interest, e.g., lend it to the gentlemen with great credit at 4.5% (he's buying a new Shelby Mustang at the dealership), pay you your sub 1% and make profit on the spread, a 3.5% return in this case.

Imagine this back and forth activity of receiving funds (from you, from me, from other institutions, etc.), covering accounts (withdrawals and transfers), and lending at higher interest rates, happening daily.  It's a lot to keep track of, isn't it?  Does this justify bank practices of lending money out to creditworthy individuals at such high rates?  Heck no!  Powerful software can handle all of this record keeping.  Personal loans by banks have an average interest rate of over 12.5%!  Today, banks also make a ton of money charging fees.  You overdraft.  That's gonna cost you.  You use the Costco ATM because they only take cash at the concessions window....that'll cost you.  What allows banks to screw us like this?

It's the FDIC guarantee, of course.  With a bank, the money you deposit in a checking or savings account, a certificate of deposit, or a money market account, is protected by the Federal Deposit Insurance Corporation.

Okay, so I have shared with you a limited view of the banking world.  If a banker came on this blog right now, she would tell me that there is much more to banking than this, and that they all deserve their pay plus bonuses (and to be bailed out indefinitely by the government).  Blah, blah.  The only banking features I like are mortgage lending and brokerages.  I'm an investor, and I rely on being able to use other people's money, but only if I can get it cheaply.  Similarly, I'm not putting my money into any entity that won't pay me more than the rate of inflation or the risk-free rate of return (the 10 year T-Note).  These are my two benchmarks.  And they should be yours as well!

Enter Peer to Peer Lending

Prosper is an online platform that pairs borrowers with investors.  Investors lend their money to single or multiple borrowers for an expected (but not guaranteed) yield.  Borrowers submit their credit, income, debt, as they apply for funds and the software spits out a rating for them.  They ask for a set amount of money, describing also why they need this money.  There are many reasons that could be provided.  For example, a borrower may want to pay-off high interest credit cards, pay for a wedding, fund a small business venture, etc.  Why do borrowers go to Prosper for their consumer loan needs?  Because they get better borrowing rates!  Banks and credit cards screw you, remember?

At Prosper, investors can "browse listings," for individual loans they can choose to fund or use the "Quick Invest" feature.  With the "Quick Invest" feature, investors set parameters for the types of loans they like, and the platform finds these, displaying them as an aggregate list.  You can hit a button and select-all, confirming the lot for investing purposes, or if you have the time, you can review each loan, clicking from your query the ones you like most.  It's an added level of scrutiny, therefore.  Do you have to fund the entire amount of a loan?  Say, a borrower is seeking $20K, and you like both the borrower's creditworthiness and what the borrower will use the money for.  Do you have to fund all of the $20K?  No.  You decide how much you want to invest.  Each borrower's loan has a bar that shows how much has been funded by investors.

Prosper also allows an investor to invest by funding what they call a Prosper IRA on the site.  This is great if all of your investment capital is in an IRA account.  A request for transfer of funds from an IRA elsewhere will have to be made so you can fund your Prosper IRA.

Can you get your money back?  Yes, you can even sell your note at Prosper.  They have created a virtual marketplace called, Folio Investing Note Trader.  There is a fee.  For this service, you will be charged 1% of the face amount of the note.   Okay, most of this stuff you can check out for yourself at the site.  The site is very user friendly and each page is very informative.

Prosper's History & Risks

I looked into Prosper's history.  It had some bumps along the road early going.  See:  Is P2P Safe.  Prosper has since been a model business and received an A+ rating from the Better Business Bureau.

What are the risks associated with investing at Prosper.  These are some of the highlights from the Prospectus broken down for you:  ProsperProspectus:

1) Loans are unsecured.  No collateral is offered.  There is the risk of borrower default.
2) Verification of borrower information.  Info may be suspect.
3)  Paying you depends on Prosper getting paid by the borrower.
4)  Borrowers may fudge on their credit scores.
5) The rating formula Prosper uses, called, Prosper Rating, may not accurately rate all borrowers.
6) If you use Quick Invest, and select poor lending parameters, then that's on you.  Also, sometimes the Quick Invest program selects loans incorrectly.  "Since it was first implemented by PMI in July 2011 through June 30, 2014, the Quick Invest tool has experienced errors that affected 8,630 Notes and PMI Notes out of the 3,372,352 Notes and PMI Notes purchased."
7) Some borrowers are scammers.
8) After 30 days of not getting a payment, chances are you're never getting it, or your principal back.
9) If our economy goes to hell....the performance of your Prosper portfolio will too since this will create a bunch more unemployed people.
10) If you decide to invest and concentrate on a few notes, you increase your chance of borrower default.

There are more associated risks that you should read on your own time.

Would I Invest And If So, Why?

Yes, I would invest with  I'd do as recommended, however, and invest my entire capital in over 100 different loans, to lower my risk of borrower default.  The chances of one or two borrwers defaulting on your principal is higher than the odds of over 100 different borrowers defaulting.  Also, if several borrowers default, say 10, that still leaves you over 90 borrowers paying down their principal and paying the interest on your notes.

Fees:  There is an annual servicing fee of 1%. The loans are either 3 or 5 year terms.  So the fees add up.  Here's an example:  However, the lender member fees are acceptable for the returns you could get.  The returns depend on your risk profile and the notes you decide to invest in.  There are excellent rated (AA/A), okay rated (B/C/D), and even junk status (E/HR) loans available to choose from and you can combine all sorts of combinations to achieve a weighted return.

Portfolio Diversification:  Having all of your money invested in the stock market is a recipe for disaster.  I have posted on multiple occassions on this blog why you need "alternative" investments to make-up at least 15-25% of your portfolio.  If you have securities (stocks, ETF's, mutual funds, AND Bonds) as well as some real estate in your portfolio, you are well on your way.  You could diversify even more by adding Prosper to your portfolio.  In the event of a stock market collapse, your real estate holdings and other alternative investments like a Prosper could minimize your portfolio's downside.

This about wraps it up folks.  Overall, I give Prosper two thumbs up.  As soon as I can free-up some cash, I think I will invest with them.  I hope this post has given you some insight into Prosper, enough to either decide to or not invest with them.

Until Next Time!  Live Long And Prosper!  Please Post Comments or Questions

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