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
“Imagine an investment that guarantees you’re going to lose money – that’s what a traditional cash reserve is doing today.” Super depressing…but very true. I have a friend who has used Kiva for some time now and has had a lot of success getting good yields.
Some of the stories on Kiva are pretty cool….helping a woman in Serbia start a taxi service by buying her a car. Pretty awesome!
I’ve been wanting to try P2P lending for a while but I live in one of those enlightened states that doesn’t allow it. On the other hand, I’m worried about just how secure a lot of these borrowers are.
Me too, FI (Texas). OG lives in the midwest, so it’s all fun and games for him. I worry about security also, which is why those default statistics come in handy. You’ll know the risk before you loan money.
I believe that Prosper and Lending Club (Prosper’s main competition in the US) both have plans to be available in every state.
I highly recommend you give the sites a try. I’ve been doing it for almost 3 years and have earned at least 10%. Have a look a lendacademy.com for a ton of great information.
I like the concept and it is certainly intriguing. I’m adding this to my list of things to look into as it definitely warrants a deeper look. I’m curious if there are statistics available as to the rate of loans that default, if it’s high enough it could rapidly erode the higher returns this can pay you.
I’ve been meaning to look into these types of options–while I’m mostly interested in the helping other aspect, I have to say that those returns are certainly intriguing!
There’s definitely something for everyone in the microloan department. I wish our state allowed them because I’d jump all over it.
I’ve thought about getting into microloans, but have not pulled the trigger on it. Honestly, I would need to educate myself more on them. The rates today are just crazy ridiculous so I can see how it would make sense to many wanting to actually earn something, as long as they’re knowledgeable about the risk.
I did the opposite, John. I read everything possible and decided it was for me…EXCEPT I didn’t read that my state decided I couldn’t do it. Sigh.
I didn’t know about Kiva and just had a look. While I don’t mind the altruistic aspect (it looks like there is no interest rate on Kiva) I wouldn’t want a default on the loan, which is more annoying than when you have a reward for your risk like with Prosper.
Agreed, Pauline. That’s definitely why the two types attract different investors with different goals. Me? I’d go Prosper all the way…but my sister (for example) would be all about Kiva.
It goes without saying that the market leader in the peer-to-peer lending category, Lending Club, is another option. Having had accounts with them since the spring of 2009, I have seen tremendous success as an investor since then. My traditional account has earned over a 10% return, after all defaults, losses, etc. Since then I have opened a second account by rolling over funds from my Roth IRA. Once they become available in your state, both Prosper and Lending Club are very viable options as alternative investments.
I’ve used Prosper before and really liked the concept. This was back in 2007 when it just came online and unfortunately I had a couple loans default. Hopefully it’s much better today.
Defaults are a fact of life. While it stinks when a loan goes belly up, your goal shouldn’t necessarily be to avoid defaults. This was my strategy for the first 2 years and I only had 2 defaults. However, you’ll find that the lenders earning the highest rates invest in riskier loans. So, they do have more defaults, but the higher rate of return more than makes up for it.
Also, Prosper is much more stable than it was back in 2007. They are now regulated by the SEC.
In line with the saying about minds (great, weren’t they) we have been looking at similar issues. Having money in the bank…well, the numbers speak for themselves. In terms of peer-to-peer landing in the UK we have Zopa – and with a diversified portfolio one can increase the yields. Also, John was looking at a platform called Nutmeg and is very enthusiastic about them (this is ETFs).
I always have my money working for me! I am really hesitant about loaning money although the returns look pretty good.
We have been seriously considering using Lending Club, but are a little bit concerned about the stability of the company. They have yet to show a profit, so we may be stuck trying to collect on a loan without a platform to collect them with.
Lending Club has shown profit in last quarter of 2012. Read this article from Mr. Money Mustache:
http://www.mrmoneymustache.com/2013/02/03/the-lending-club-experiment-four-months-later/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+MrMoneyMustache+%28Mr.+Money+Mustache%29
Thanks for this, I use kiva already but had never heard of Prosper.
I’ve also using lending club and it gives you a great opportunity to spread out your risk. There are also larger loans with mid sized companies that can be bought as private investments as well. You need to ask yourself what portion of your investment portflio you want to be a loaner and what portion you want to be an owner and then look at all the options on the table.