Why I Will No Longer Invest Via Lending Club

I've written several posts about my foray into Peer-to-Peer Lending via Lending Club and Prosper, and in the past few weeks I've read several (probably sponsored) articles encouraging people to invest via these platforms.   After reading a bunch of blog posts several years ago, investing some money on these platforms seemed like a good idea.  Now, after about three years, I am in the process of withdrawing my money and I do not advise anyone to put their money into these platforms.  Why?

The Reward Does Not Compensate for the Risk

Bank accounts don't pay much, but you know you aren't going to lose money.  You can lose everything investing in the stock market, but you can also double or triple your money, or more.  The upside of bonds is limited, but the risk of your investment being worthless can be limited by investing in high-quality bonds.  After investing via Lending Club and Prosper for three years, I have no trouble saying that the rewards do not compensate the average investor for the risk being taken.

Default Risk

Both Lending Club and Prosper warn investors to expect defaults--that's the nature of unsecured loans.  Some people will pay them; some people will not.  The unfortunate fact is that lenders have to make enough money off those who do pay to compensate for those who do not.  

At different times, the overall default rate increases or decreases due to the overall economic health of the country.  When times are bad, more people lose their jobs and when people lose their jobs, unsecured loans are the first payments skipped.  The rates charged for loans have to consider not only what the rate is likely to be today, but what will likely happen if the economy tanks.  I'm not earning enough today to convince me that I wouldn't lose money if the economy tanks.  Too many people are defaulting now--in April my average balance with Lending Club was about $9,200 and, after defaults, I earned $6.89.  Since unemployment is low and the economy is basically doing well, I have to believe I'd lose money if we move toward a recession.  

Lending Club publishes statistics about its overall portfolio and about what returns can be expected.  You can see them here. When I started investing via Lending Club, the norm from which it was hard to stray if you had a reasonable sized portfolio was about 8%; now it is about 5%.

Underwriting Risk

Before investing via Lending Club and Prosper, I did my homework.  I read articles.  I read the statistics on their websites.  Everything was showing average returns in the 8% range.  With returns in good times in that range, I figured there was room for some defaults in bad times.  Then something changed.  Interest rates went down and underwriting standards were made less stringent, which resulted, of course, in more defaults.  

The big difference between Lending Club and your local bank or payday lender is that the bank and payday lender are loaning out their own money. If you don't pay back your loan, they lose money.  If a Lending Club borrower defaults, Lending Club doesn't suffer the loss, the investors do.  Lending Club makes their money via origination fees and via service fees (they take a small percentage of each loan payment).  It is in Lending Club and Prosper's best interest to facilitate as many loans as possible.

There are two ways the conflict between investors and the platforms comes into play.  First, as noted above, is when the platform lowers interest rates or credit qualifications in order to increase loan volume.  The second is when the platform solicits current borrowers to refinance loans at a lower rate.  The platform gains an origination fee.  The borrower (hopefully) saves money.  The investor loses because the high-interest loan is paid off early and therefore with less interest.  Also the 1% service fee on the lump sum repayment can consume several months interest.  

Lack of Knowledge

I am not an expert on underwriting loans.  As a matter of fact, I know very little about it.  When loans are offered on Lending Club and Prosper, certain data points are made available to investors, but I lack the ability to analyze that data to determine in the offered interest rates are sufficient.  Banks and their computers do not have that problem, and more and more of the loan volume on Lending Club and Prosper are being purchased via computer by institutional investors.  I have a hard time believing those computers will not skim the cream of the loans, and I can't even identify the cream.

You used to be able to find blog articles about "filtering" Lending Club or Prosper loans--searching the offered loans for those meeting certain criteria that historically (short as "history" was) had done better than average--and then purchasing those loans.  NSR Invest offers a tool that allows you to back-test your strategy--to see if filtering out certain loans or looking for others would have increased your return on investment IN THE PAST.  The problem is that Lending Club and Prosper can (and do do change the rules at any time.  Unless you have a very good understanding of how the criteria for rating loans now compares to the criteria used in the past,  you can't use a back test tool to do anything except to see what might have happened in the past.  

My experience with Peer-to-Peer Lending has convinced me that loaning money to other people is a business best left to those with expertise.  Do you agree?  

*Part of Financially Savvy Saturdays on brokeGIRLrich.*

Mutal Funds, ETFs, Closed End Funds--What's the Difference?

One key rule in investing is to not put all your eggs in one basket--or all your money in the stock of one company.  No matter how great the company, no matter how long it has been in existence or how well known it is, it could fail--case in point:  Sears.  While Sears has not yet filed for bankruptcy (at the time of this writing), "word on the street" is that it is coming.  Sears has been a retailing giant since the 1800's and sent packages through the mail long before Amazon came into existence. 

The problem with buying a large number of investments is that researching them and following them takes too much time, even if you have learned how to do it.  Yes, there are investment geeks out there who love reading annual reports, who know what PEG, PE and EPS mean, and who revel in uncovering stocks no one else has heard of, but most of us would rather go to the beach, and outsource the job. Of course investment companies have seen the need and developed products to meet that need.  Today we are going to take a look at three types of products you can buy that basically pool your money with that of other investors to buy shares in many companies.

Open-Ended Mutual Funds:

Open-ended mutual funds are still the most common type of pooled investment vehicle, but Exchange Traded Funds are making headway.

With an open-ended mutual fund, a custodial company develops a plan stating the types of things in which it will invest, as well as the long-term goals.  This plan, which is described in a Prospectus gives investors some idea of what they are buying--is it stocks, or bonds?  Big companies, or little?  Is the goal current income or increasing share price?  Are people picking the investments or is a computer matching an index?

An initial share value is established and as investors send in money, the fund managers invest it per the prospectus.  If the initial share value is $10 and your money gets there the first day, you purchase one share for every $10 you invest.  As the purchased investments appreciate (get more valuable) or decrease in value, each share price adjusts proportionately.  Every day at the end of the day the NAV or Net Asset Value per share is computed.

With open-ended mutual funds, investors can buy more every day, and new shares are created, priced at the same NAV as the old ones are that day.  As more money comes into the fund, the fund managers invest it.  If more investors want to withdraw funds than contribute, then the fund managers have to sell assets, whether or not they think doing so at this time is wise.  As money comes in, the managers have to invest it per the prospectus--for example, if the prospectus limits cash to 10% of the fund assets then once cash reserves exceed 10%, they have to be invested per the prospectus, regardless of whether the managers believe it is the ideal time to buy those investments.  

Open-end mutual funds are the most common investment offered by 401(k) plans.  There are thousands of funds with a variety of investing styles and goals.  Mutual fund investments are made by dollar amount, not by share amount, and most fund companies require an initial minimum investment. 

Exchange-Traded Funds:

Exchange Traded Funds are similar to open-ended mutual funds, except that while mutual funds are valued at the end of the day and everyone who buys and sells shares that day gets the same price, ETFs are valued minute by minute as the value of the owned stocks change.  If you buy an ETF for $10 per share in the morning, I may be able to buy the same ETF for $9.00 per share in the afternoon--or it may cost me $11.00.  

Because the price of the shares fluctuate throughout the day, ETFs are purchased by shares, not by dollar amounts, so you only need the cost of one share to start an investment. They also can be bought or sold almost instantaneously, depending on your broker, so if you want to time the market, or set stop-loss or limit orders you can.  Some brokers charge a commission for buying or selling ETFs, though generally if you purchase directly from the managing company, there is no sales commission.

Closed-End Funds:

A closed end mutual fund is one in which a limited number of shares are sold.  If someone who owns shares in a closed-end fund wants to sell them, they are sold on the stock exchange for whatever price can be obtained, which may be the same, more, or less than the proportionate value of the fund assets.

For example, FundA may be, for simplicity sake, invested 1/4 in ABC, 1/4 in DEF, 1/4 in GHI and 1/4 in JKL today.  The NAV of the shares is $10.00, so each share of FundA represents $2.50 of each company.  Tomorrow, there is really bad news about ABC and the price drops by 20%, and the other companies' price remains the same.  Now, the NAV of the shares of FundA is $9.50.  If FundA was an open-ended mutual fund, and it received my order for shares tomorrow, I would pay $9.50 per share--and that' s what you would receive if you wanted to sell.  However, with a closed-end fund, if I wanted to buy shares in FundA, I would have to go to the stock exchange, and pay the going rate, just as if I was buying the underlying stocks.  It is not uncommon for closed end funds to sell at a noticible discount or premium to the NAV.  If more people want to buy FundA, then the price goes up; if "everyone" wants to sell, the price goes down--however, there are still the same number of shares of FundA in existence, and each share is still invested in ABC, DEF, GHI and JKL.

For fund managers, the advantage of closed-end funds is that they have a set amount of money with which to work.  With open-ended funds, if there is a large in-pouring of assets, then fund managers may have trouble investing it in companies in which they believe and in accordance with the fund prospectus.  Closed-end funds don't have that problem.  In the same way, if too many people want to withdraw money from open-ended funds, the managers can be forced to sell assets when the value is down.  With closed-end funds, the investor might suffer a loss in that situation, but the fund as a whole would not.  

Investors benefit because without having to manage funds coming into and out of the fund, the operating expenses of a closed-end fund are less than that of an opened ended one.  Further, if you are looking for income, closed end funds tend to pay shareholders regularly--passing on both the dividends paid by the underlying stocks and the capital gains earned when stocks within the portfolio are sold.  

I own a few shares in a closed-end fund--Liberty All Star Equity Fund (USA), which is a large cap fund.  Its major holdings include Adobe, Visa, Amazon and Alphabet.  You can read more about it here.   Liberty tries to pay out 2.5% of the Net Asset Value of the fund each quarter to shareholders, which means it is good for those who want income.  Today it is selling for 6.99% less than the NAV.  On the other hand, a sister fund focused more on growth is currently trading at 6.6% more than the NAV.  

I am due to collect a distribution of $0.17 per share.  My shares cost an average of $6.29 each, and closed today at $6.25.  The current Net Asset Value per share is $6.72  

So, is buying this fund a guaranteed 10% return annually?  No.  If the fund does not have enough earnings to cover the distribution, it makes up the deficit by returning capital to the shareholders; in effect giving you some of your money back, which of course lowers the NAV (and probably the market price) of the shares.  Still, if you want to know that on four days of the year, you will receive a check for more or less an amount of money, closed end funds may work for you.

Overall, USA's annualized performance over the last ten  years has been 8%, which is slightly less than the 9.62% return of Vanguard's Total Stock Market Index Fund, and slightly more than the Lipper Large Cap Core Average, which the fund considers to be its benchmark.  

Stock Screeners

You've decided to do it.  You are going to invest in stock--you are going to buy shares in some company, rather than a mutual fund of ETF.  Now, how do you pick which one.  One way that has been successful for many people is buying what you know--if there is a business you patronize and love, buy a part of it, or at least use a list of such companies to begin your research.

Another way is to set some basic criteria, run some computerized screens on those criteria and then further research the results of those screens.  The advantage of this method is that it can call to mind companies you had no idea existed.  While a computerized screen should not be your only criteria for investing a substantial (definition of "substantial" varies by person) amount of money in a company, computerized screens are good for eliminating companies from consideration.  Let's take a look at some available on-line stock screeners.

Finviz

Finviz  is the screener that seemed the most intuitive to me.  Above is a screenshot of their screener.  offers both paid and free accounts.  The paid account costs $24.96, and this chart compares the free and paid versions:

To use Finviz, you simply go to their homepage, click on screener and, for the most complete screen, click on "All".  (The other choices are "Descriptive" "Fundamental" and "Technical").  Click the boxes on which you want to screen, enter the criteria that interest you, and then look at the results list.

As an example, I want to invest in a small cap company that is profitable, has increasing earnings per share and has a dividend above 3%.  I'm not saying this screen will result in outsized earnings, I just needed something to start with and that's what I picked. 

Finviz' screener covers 7319 companies.  Screening for small cap reduced the number to 1564.  Asking for dividend yield over 3% cut that to 372.  When I added in positive earnings per share growth this year, the number went down to 148.  Setting "net profit margin" to positive, further reduced the list to 107.

Once I've gotten a number of stocks with which I can work.  I can design my own report using the screening criteria I used, or another criteria.  For example before I buy this stock, I want to know if their sales are increasing, and what the price/earning ratio is.  I go to the report tab, click those buttons, along with dividend yield and then I take a look at my report, which I can then sort on any criteria I've included in the report.  In this case, I decided to sort on Sales Growth in the last five years and Jupai Holdings, a financial management company from China comes to the top. 

Interesting; this would NEVER have come on my radar in much of any other way.  So, should I buy it?  Well, when I click on that stock, I get a page filled with data about it,and a quick eyeball shows that it is a growing and profitable company but that the stock price is volatile and down for the last three months, but that it doubled in the last year. If I continue down the page I see a slew of articles about the company, including one published this week on Simply Wall Street titled Top 3 Cheap Stocks This Month.  There is also a link to their annual report. 

The main downside to Finviz is I think the page is unattractive and hard to read.  Also, unless you buy the premium version there are ads, including videos and I hate video ads. 

Yahoo

Yahoo offers a stock screener as well.  While it does not say how many companies it starts with, when I clicked "Small Cap" I got 5245 results.  When I went to look for dividend yield, I couldn't find it, so I hit control-f and let the computer do it for me.  I found one that was dividend/stock price, so I clicked it.  For earnings per share I clicked net EPS--basic.  The trouble was that once I clicked those, instead of being able to set them where I was, I had to go to another screen, and though I set the dividend screen to what I thought was the equivalent of dividend yield, I ended up with stocks with dividend yields that were less than 3% (and some more) so obviously I did it wrong. In general I had a harder time navigating Yahoo's screener and I wasn't able to select criteria that I knew were equivalent to those I picked for Finviz (and vice versa).  I guess knowing something about finance would be useful. 

For whatever reason, CVA Covanta Holding Corporation was at the top of the list Yahoo gave me.  I clicked on it and was taken to Yahoo's page on Covanta where you can see there is a lot of information, including the fact that it is considered a strong "buy" right now.  This page is easier to read than the individual stock pages on Finviz, and seems to have much of the same information.  In short, I prefer screening the stocks on Finviz, and then reviewing the "winners" on Yahoo finance.  

Zacks

Zacks is helpful because it defines the various screening criteria and tells you what it thinks are reasonable values.  I screened for market cap under 1000 per their criteria for small cap.  I picked a dividend yield of greater than or equal to 3%.  My screen selected 98 stocks.  Interestingly, neither of the stocks discussed above were on that list.  

Zacks listed the stocks in alphabetical order but allowed me to sort by any of my criteria.  I sorted by dividend yield and the top one was Independence Realty Trust, and clicking on the name took me to Zack's page  on it.  I found the page easy to read and liked the fact that one of the top things you see on the page is Zack's recommendation about the stock--in this case "sell".  The other thing I like is the little i  buttons next to some terms.   

While Zack's is selling a premium service and therefore paywalls a lot of their information, there is still plenty available to those who do not subscribed. 

Are there any stock screeners you like to use?

*Part of Financially Savvy Saturdays on brokeGIRLrich.*