I've always wondered about Prosper.com -- the site that connects borrowers and lenders -- and whether or not it was s good investment. For instance, if people were earning 15% on their money by lending it to others, maybe I would want to get in on the action with part of my portfolio.
MSNBC recently did a piece on Prosper and included was how much the lenders make. The details:
Each Prosper borrower is assigned a grade based on their credit score to help lenders evaluate their risk and the site verifies borrowers’ identities. The average rate of return for lenders is 9.28 percent, with lower-grade loans earning 10.45 percent, according to Prosper.
Prosper makes its money by charging a 1 percent or 2 percent closing fee, based on the borrower’s credit grade, and lenders pay an annual loan servicing fee of 0.5 percent to 1 percent. It also collects fees for late payments on behalf of lenders and reports to credit bureaus. After 30 days, a collections agency is assigned to delinquent loans.
Ok, so what's not clear here is whether or not the fees are deducted from the earnings in the numbers above (I'm assuming the 1-2% closing fee is paid for the borrower.) In the best case-scenario, lenders are earning 9.28% to 10.45% -- in the worst case (if the annual fees get deducted from these numbers) the results are about 1% lower.
Either way, it doesn't look like something I'm interested in for investment purposes. Yeah, there's the "read people's stories, get involved, and help them out" angle associated with Prosper, but I'm ignoring that. I'm looking at it as an investment and whether or not it's a good option for me. And to be a good option, I needs to beat my main investment of choice: index funds. But it doesn't. Here's why:
1. Stock index funds will average about 10% return over the long-term. That's roughly what Prosper loans earn too -- at best. It could be 1% lower. And we all know that over a couple decades, that 1% can make a really big difference in your total investment return.
2. The Prosper loans take a lot of time to select and manage -- at least more than index funds do. The latter are easy, especially when you set up your investments automatically.
3. Index funds seem less risky. It's not that stocks are without risk, but do I really want to lend money to someone who can't get a loan from a bank? Think about it -- people who do this professionally (bankers) have said this person is a bad risk. So why do I want to give them money.
I know I'll get some Prosper success stories in the comments. I'll hear how some people are making more than the numbers above, they've never had a default, and how it doesn't take much time to invest with Prosper. That's great for them. But to me, I have other options that I feel return as much or more, require less time to select and manage, and have much less risk. So why would I want to move my money from them into Prosper loans?