Sometimes it takes a little creativity to reach your destination.
The world economy continues to slowly gain traction but many cash investors aren’t seeing that translate to increased yield in their short and mid-term cash investments. According to Bankrate.com, the average yield for a $10,000 money market investment was a paltry 0.52%. That’s a whopping $52 per year, excluding any fees or costs, and definitely excluding inflation. Last year, the Social Security Administration increased retiree benefits by 1.7% to offset increasing costs. Based on that inflation adjustment, investors are losing purchasing power each and every year by doing what at first glance appears to be the right thing: investing in a reliable money market account.
Imagine an investment that guarantees you’re going to lose money – that’s what a traditional cash reserve is doing today. That’s why so many bloggers lately question the need for an emergency fund at all. Don’t fall into that trap.
Microloans: A Primer
Microloans are very small loans made to borrowers who typically lack collateral to support the loan. Sometimes, microloans are also made to those who don’t have steady employment or even verifiable credit. There are two well-known microloan organizations – serving a completely different market. The most well known peer-to-peer lender is Prosper.com. They have over 1.6 million customers and have funded over $400 million in loans to their members. Prosper.com helps connect borrowers who have reasonable credit with lenders who are trying to earn a higher return on their money. The other micro-lending site is Kiva. They primarily help people and families across the world to “create opportunity and alleviate poverty.” Between the two, Kiva seems altruistic, whereas Prosper seems more capitalistic.
How To Earn Money
While both Kiva and Prosper offer the opportunity to lend money to whomever you wish (and for whatever purpose you wish), Prosper created a system to help those who want to use Prosper as an investing tool. On their website, they breakdown all the financial metrics for the different types of loan ratings. Prosper also provides advice on how to create a “diversified” portfolio of microloans. (Diversification is important when investing in loans – some are going to default!)
Returns on these investments are beyond enticing – Prosper’s best members, those they rate AA – have an average credit score of 808 (well above the national average). Those AA loans have a historical loss rate of 1.70% – but have an average return of 5.50%! That’s leaps and bounds above our Money Market rate listed above. The lowest rated Prosper members (credit score 683) have a 14% loss rate and a 13.29% average return. A well-diversified portfolio of Prosper loans could make an attractive portfolio.
It’s Not All Roses
This may seem like a great “fire-and-forget mission” and in some ways it is, but there are some things you’ll need to recognize before you invest in microloans at a place like Prosper. First, the loans are three years long, and there’s no way to get your money back early if you truly need it. Secondly, you will experience some defaults. As I mentioned above, even the highest rated consumers still default. You need to realize you’re becoming the bank! Prosper recognizes that their traditional model doesn’t suit everyone, so they have created their Prosper Trade Notes program, but even that comes with it’s own long list of pros and cons.
Sum It Up
If you have some extra cash reserves – money that you know you aren’t going to use for at least three years – Prosper.com could be a viable solution to increase your yield. If you want to loan money for a more altruistic purpose, consider Kiva. Both of them serve a specific purpose, but Prosper has a greater chance to provide a consistent income stream for the investor.
Photo: Philip Taylor PT
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