Friday, June 20, 2008

Planning to Prosper

It has been quite some time since I wrote about Prosper loans. Prosper, like many sites now available, is a site where peers can lend to other peers. Prosper effectively removes the banks from the transaction and that is the value that they are selling.

The upside for the borrower is a lower interest rate than would be possible through a conventional loan. This is ultimately where I think that the average lender is starting to get screwed. I don't blame prosper here. As a borrower, it is enticing to see that you have a chance to make serious money in double digit percentage rates on a loan when your high-yield savings account is yielding only 2 or 3 percent.

The upside for the lender is supposed to be a higher interest rate and therefore more income per dollar invested. However, it is easy for the average investor to consider returns without considering some of the more fundamental concepts of Modern Portfolio Theory.

Risk and reward are related, even within the Prosperous world of peer to peer lending. To their credit, Prosper has improved their site by adding in calculators that help users understand the total return for their investment. But the loans are still bid up, and bid up quickly. As with most investments, these things are personal.

Plan for reality with prosper though. My experience shows that even with serious scrutiny, these loans are often not worth the paper they're written on. Twice I've seen serious delinquencies and sometimes they are paid off dramatically before the due date. While I am thrilled that this helps people get out of debt, it can seriously eat into your returns.

As for me, my hand at picking decent loans has not been great and I would prefer to put future investment dollars into a more traditional form of investing. My words of advice would be simply to beware of the idea of diversification through multiple loans. The reality is that all of these loans are dependent on the economy generating income producing jobs for these borrowers to work at and make the money to repay them. Let's face it, if they had the money, they wouldn't need the loan! From that perspective, multiple prosper loans is not really diversified.

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