One of the most interesting tasks we have within the peer to peer lending community is trying to convince others how Prosper and Lending Club are good investments. After all, only a small portion of people have even heard of peer to peer lending, much less understand what it is.
A Common P2P Lending Conversation
I imagine many of us have run into this problem with our friends or family members. While we may have personally come to accept peer to peer lending as a great way to invest, most of our close-knit relationships are still unaware it exists, or are unconvinced that it is a great way to put their excess cash to work. A typical conversation with a friend might sound like this:
Investor: “Hey friend, have you ever heard of peer to peer lending, a way to invest through companies like Prosper or Lending Club?”
Friend: “Nope. What is that?”
Investor: “It’s really great. You lend out your extra cash to people around the country who need a loan. They repay it slowly with interest.”
Friend: “Like Kiva?”
Investor: “Sort of, but to Americans. I’ve earned 9% per year on my investment. I actually invest through an IRA, so it’s even tax-free.”
Friend: (looking distracted) “Uh, interesting. Gotta go! I’m signing up today for a Fidelity ‘Growth Fund’ that, while rising and falling with wild abandon, could theoretically earn me an 8% return (but probably won’t). This actively-managed fund will eventually take $150,000 in fees from me before I die. Hey, is that a violin?”
Investor: (playing Shubert) “It’s a viola. My 9% Prosper returns are so boringly consistent I’ve finally had time to master Arpeggione Sonata.”
Perhaps your conversations have not gone exactly like that, but the fact remains that we need to identify convincing reasons to help people begin lending.
8 Ways to Convince People to Open a Prosper or Lending Club Account
There are many reasons investors lend through sites like Prosper and Lending Club. However, if you are trying to convince a doubtful friend or family member, here are eight of the best:
#1. Highlight the Great Returns
Nothing gets heads turning like raw ROI (return on investment). As stated in the recent post P2P Lending: What is an Expected Return?, the diversified lender can expect to earn between 5% and 12%, depending on their degree of risk and skill. Let’s look at this more closely. Below you will see the return for Lending Club’s 2009 3-year loans, which by now have all been paid back in full (or defaulted):
And here is the same table for completed loans from 2010:
While remembering that past performance is no guarantee of future returns, these two tables are quite compelling. Across all loan grades (levels of risk A-G), peer to peer loans have historically given investors a 6-7% return. This return can climb as high as 12% or 13% (see my portfolio) if an investor takes on riskier loan grades and develops a good selection criteria. Read about ways to increase return in my Lending Club Strategy or Prosper Strategy posts.
#2. Trumpet the Growth of Prosper & Lending Club
If anything is easy to applaud, it’s the thundering momentum of p2p lending.
Year after year, peer to peer lending as a whole is going in one distinct direction: up. While only a small portion of Americans today know and understand the nature of this investment, you can bet this situation will soon be different. It has been theorized that peer to peer lending could eventually issue $200 billion in loans. Nobody really knows how high things could go, but if this $200B number is accurate, it means we are not even at 2% of what is possible.
#3. Highlight P2P Lending as an Alternative
During the financial crisis of 2008, the United States was in a collective tail spin. Not only did the sub-prime mortgage situation upset weighty indices like the Dow Jones Industrial Average, but nearly every retirement account and international market was negatively affected as well. The unified panic exposed how deeply connected everything is. For example, the housing market emergency caused massive shockwaves in things as unrelated as the price of copper (source):
However, the above graphic also shows how much of an alternative peer to peer lending is as an investment compared to everything else. When the sub-prime mortgage crisis sparked a global panic in 2008, and the price of copper dove into 2009 with so much else, the average Lending Club return remained a cheerful 6.1%. Then, as the price of copper recovered to new highs, returns at Lending Club even went down slightly.
This does not mean peer to peer lending is free from risk or negative national factors like unemployment (quite the contrary). However, the above chart is evidence that peer to peer investing is an alternative to the crazy noise that is the global financial system. For people who have assumed that they have no choice besides saving for retirement through mutual funds, this could be wonderful news indeed.
#4. Mention Lending Club & Prosper’s Stability
While we’re on the subject, a great way to convince others of peer to peer lending’s merit is to talk about its low volatility, meaning, how stable the returns continue to be, year after year. People often imagine alternative investments as crazy things that give high returns at one time and low returns at another. Peer to peer lending, on the contrary, is quite the opposite:
The above graphic demonstrates this fact in great detail. It is a screenshot from a presentation Renaud Laplanche gave at the LendIt conference in June, highlighting how the default rates at Lending Club have continued to be amazingly consistent year by year. The default (charge-off) rate is the percentage of the loans that fail to get repaid by borrowers, and this rate has largely stayed the same since 2009. Without making guarantees, this means we are more likely to earn a similar return in 2014 as we did in the past five years.
#5. Forward Articles from the Wall Street Journal
If people struggle to be excited by the returns or consistency, perhaps they will be swayed by press clippings. For instance, you could send them this recent Wall Street Journal article “Consumers Find Investors Eager to Make ‘Peer-to-Peer’ Loans” that includes a peer to peer lending side-graphic. It features great pictures and quotes from Prosper’s management team. Or forward to them this recent article from Business Insider that calls peer to peer lending the nation’s “Hottest New Investing Trend“. Finally, they may be eager to read the recent Forbes article titled “Peer-To-Peer Lending Challenges Too-Big-To-Fail Status Quo“, an article that questions the notion that America actually needs big banks at all.
#6. Invite Them to Start Small and Exit Easily
Experimenting with Lending Club or Prosper is a somewhat low-commitment act. Lending is easy to try out, and an investor can quit anytime. For instance, most individual investors test the p2p lending waters with a small trial investment. This is quite easy to do, since both Prosper and Lending Club have allowed a minimum note (portion of a loan) of $25. You may not be fully diversified with just a single $25 note (see the benefits of diversification), but you can get a decent sense of the lending process as a whole.
Furthermore, peer to peer lending is a fairly liquid investment. This means you can pull your money out somewhat easily. Peer to peer notes are classified as securities, so a secondary market exists that allows their sale and repurchase. If an investor decides he or she is done, they can liquidate their investment on the secondary market (Foliofn). Often notes sell immediately if priced at face value.
#7. Highlight Peer to Peer Lending’s Simplicity
This is something that has not been talked about enough. Peer to peer lending, unlike investing in stocks, bonds, or mutual funds, is really stinkin’ easy to understand. If you invest in a mutual fund, things get confusing fast. Suppose you invest in a Fidelity retirement fund that invests in hundreds of companies, including 0.8% in Apple stock (AAPL). After moving cash over from your checking account, your investment would go to purchasing shares of the fund, shares which would be split into hundreds of different companies, with each entity having thousands upon thousands of expenditures themselves. Needless to say, by the time your investment sliver reaches an Apple employee, it has passed through so many middlemen that it is basically a half-digested lump of its former self. All the while, Fidelity would be taking 1-2% of your earnings in fees.
In contrast, peer to peer lending is simple and elegant. You are simply lending people cash. Borrowers either repay you or they don’t. Period. The fees are low and the platform data is transparent. Prosper and Lending Club only make money if their investors do as well. Certainly, there are detail-rich aspects to becoming a good lender (like filtering loans), but overall the process is more uncomplicated than anything around.
#8. Emphasize How Peer to Peer Lending Helps People
If all else fails, it can help to simply talk about peer to peer lending’s ethics. Peer to peer lending is good for the United States. It is good for society. The people who are taking out these loans are generally not reckless individuals with a sudden desire to open a tattoo parlor. Instead, they are premium borrowers with good credit who are generally using their loan to get out of credit card debt. They are moving from the ugly 25% interest rate on their Chase credit card to a peer to peer loan with a more reasonable rate, often 7-15%.
Have you ever blessed people with freedom through your Roth IRA? I have.
An Investment with a Promising (Though Uncertain) Future
How widespread will peer to peer lending ever become? Will it remain forever an investment option mostly used by those skilled in finance or technology? Or will the average American, fifty years from now, be well versed in the practice and language of lending money online?
I believe the answer lies somewhere in between. The returns are just too consistent and rewarding for this investment option to remain unnoticed. That said, it does take a small degree of know-how and comfort to simply open a lender account and diversify an investment into 200 notes. Lending Club and Prosper may eventually offer public funds, which would help, but the best experiences seem reserved for those who have the time and energy to learn the ropes of peer to peer lending for themselves.
That said, thousands upon thousands of financially proficient independent investors are still unaware that peer to peer lending exists. If you know one of these individuals who continues to be on the fence, my hope is that the eight arguments outlined above will help change their minds.
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