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Should I Join a Direct Investing Program?

Question: Are direct investing programs like Lending Club and U-Haul Investors Club a good idea for average investors?

– Henry

Answer: In general, investors should consider all their options, not just the roads most traveled.  But your specific answer will depend on how how much risk you’re willing to assume and whether, at any given moment, these services offer higher yields than traditional investments.

The securities universe mostly consists of two basic choices: debt (including bonds and loans) and equity (including stocks and business partnerships). The programs you mention are examples of debt securities.  At one end of the debt spectrum are regulated, liquid bonds like Treasuries, municipal bonds and corporate bonds.  Investors can buy and sell these with relative ease and have access to plenty of information, including financial statements and third-party opinions from bond-rating agencies.  But, because so many investors compete for returns in these bonds, attractive yields aren’t always easy to find.

At the opposite end of the spectrum are purely private debt investments like “hard money” loans and private mortgages.  Experienced investors can earn solid returns with such investments, but they must be able to perform their own analysis, stake large sums for long time periods and take appropriate action in the case of late payments.

Investing programs like the ones you mentioned are a middle ground.  The securities are registered with regulators and subject to reporting requirements, but they’re not especially liquid, so they’re best for long-term holders.

Peer-to-peer lending services like Lending Club match investors with borrowers while providing credit information and collecting a fee.  U-Haul Investors Club specializes in loans that are backed by hard assets like trailers.  Neither program has a history of returns as extensive as that of standard bonds, but then, neither idea is a radical departure from private lending.  Investment minimums are lower, and what investors lose to fees they might gain from convenience.

To decide whether these or similar programs offer good deals, review plan information carefully and then compare rates with those available elsewhere.  The WSJ.com Market Data Center is a good place to look for rates.  For example, the 10-year Treasury, which carries minimal credit risk, recently yielded around 2%, while a Merrill Lynch index of high-yield or “junk” corporate bonds recently yielded over 8%.


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    • There are site out there like http://www.dripadvice.com that provide info on directing investing through company sponsored dividend reinvestment plans.

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    • Peer-to-peer lending programs are extremely convenient and they’re actually kind of fun to browse through. There are a lot of very interesting requests for capital that come through there. Most importantly, they’re regulated. So, at the very minimum, an investor knows that what they’re investing in is real (theoretically).

      On the other hand, the biggest flaw that I perceive with P2P lending is that they’re largely unsecured loans. In other words, they’re “credit loans,” not loans that are backed with hard collateral and the borrowers are not savvy individuals. Lenders have no real recourse in the case that borrowers default on their loan.

      I don’t mean to say that success can’t be had in this arena and the platforms that are set up for P2P lending are definitely very evolved and well-structured. You can be making loans with the click of a button. But, the risk-reward ratio that they present is really pretty out of whack when you compare it to other investing opportunities (i.e. hard money loans and private mortgages, which are both mentioned in this article). Well-secured debt investments like these offer much better returns. The trick is, like the article mentions, you have to know what you’re doing and make sure that you’re working with investment sponsors that you trust.

      Chris Gleason
      Managing Director | MMG Capital
      (310) 295.1121 (ext. 301)

    • Greek gov’t bonds have a pretty good history of return right? The rates seem terrific in any case. I think I’ll just buy some of those.

    • Henry,

      Of course when investing, every investor has to evaluate the risk/rewards of a particular investment to know if it’s right for him or her. That being said, allow me to give you more information about peer-to-peer lending.

      The two major peer-to-peer lenders of unsecured loans in the US are Prosper.com and Lending Club. Prosper was the first, starting back in 2006 and Lending Club followed. Both are regulated by the SEC.

      Both use similar systems. Borrowers apply for loans, get pre-approved, are given an interest rate and post their loan request on the site. Then lenders review loans on the site and invest in small increments as low as $25. Thus, a $5,000 loan request may have dozens if not hundreds of lenders. Once the loan is funded, the borrower makes a payment (of principal and interest) to Prosper or LC and the money is than distributed to all the lenders on that note. Notes are 1, 3 or 5 years in length.

      Of course, every lender diversifies himself and may invest in hundreds if not thousands of notes. Lenders can control their portfolio by investing in any combination of high interest / higher risk notes and low interest / lower risk notes. On Prosper yields on notes range from about 5% to about 30%. On Prosper, since July 2009, the average investor has an annual rate of return of 10.7%. This is after defaults which are baked into the borrower interest rates. I can’t speak for Lending Club, though they do give returns information on their site.

      Peer to peer lending can be one well-performing part of your overall investment portfolio. The nice thing is you can start out with a small investment and work your way up. Investors on both Prosper and LC have as little as a few hundred dollars on the platform up to institutional investors who have up to $10 million.

      Obviously, I think Prosper is the best peer-to-peer investment, but I don’t wish to spam here. However, you are welcome to contact us if you have more questions.

      Glenn G. Millar
      Prosper.com Employee

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