With the rise of fintech and p2p lending platforms, investing in lending club has become an attractive option for many investors looking to diversify their portfolios and earn attractive returns. However, while lending club investing offers potential high yields, it also comes with risks that need to be properly understood and managed. In this article, we will take a comprehensive look at the pros and cons of investing in lending club, the different investment options, expected returns, risks, and tips for getting started.
Lending club investing provides easy diversification and potential high returns
One of the biggest appeals of lending club is that it offers easy portfolio diversification into consumer loans and small business loans. Unlike investing directly in individual loans, you can invest small amounts across hundreds of loans on lending club’s platform, providing instant diversification. The lending club platform also allows automatic reinvestment, keeping your money constantly working.
The attractive yields also make lending club investing appealing. While average stock market returns are around 7-10% annually, lending club notes historically have averaged 4-7% in net annualized returns for safer grades and over 10% for riskier grades. So properly investing in higher yielding grades can provide equity-like returns from fixed income products.
Defaults and lack of liquidity are the biggest risks of lending club investing
However, the higher rewards also come with higher risks. The two biggest risks are defaults and lack of liquidity. Since you are investing in consumer loans, there will inevitably be defaults that will lower your returns. The key is to properly diversify across loans and risk grades. Also, on lending club’s platform there is no secondary market for the notes, so you cannot easily sell your holdings – making this a highly illiquid investment. You have to be prepared to hold loans to maturity.
Stick to more diversified investment vehicles to mitigate risks
Rather than cherry-picking individual notes, utilize more diversified investment vehicles on lending club’s platform to mitigate risks. The most popular options are the automated investing tool or managed funds through partners like LC Advisors. The automated tool allows you to customize investment criteria like risk grades, income levels, loan purpose etc and automatically builds a diversified portfolio. The LC managed funds provide instant diversification across hundreds or thousands of notes, taking the guesswork out. While returns may be slightly lower, the diversification significantly reduces default risk compared to picking individual notes.
Consider lending club as a portion of your high risk allocation
It’s important to size your lending club investment appropriately based on your risk tolerance. The high yields come with equally high risks, so lending club should not make up a significant portion of your portfolio. Consider it as part of your high risk allocation, similar to small cap stocks or emerging market equities. Limit it to 5-10% of your total portfolio value. And only invest money you are prepared to lose given the risks involved.
Do your due diligence and start small
As with any investment, you need to do your own due diligence before investing large amounts of money. Take the time to understand lending club’s underwriting criteria, historical returns across grades, fee structure, collection practices etc. Start small with little money at first while you learn the ropes. Over time you can increase allocation as you get more comfortable. Patience and taking the time to learn will pay off in the long run with lending club.
In summary, lending club investing can provide attractive high-yield returns but comes with significant risks like defaults and illiquidity. Mitigate risks by utilizing diversified investment vehicles rather than picking individual notes. Consider lending club as a high risk portion of your overall portfolio and do your due diligence before increasing allocation.