Peer-to-peer lending site LendingClub has a feature called LendingMatch that allows you build a portfolio of multiple notes simply by choosing a desired risk profile. Even though I’ve funded over 30 loans, I never touch the thing. Now, I think in general LC does a decent job rating their loans from A1-A5, B1-B5, all the way to G5. But sometimes I just don’t agree with their assessments, and other times I have a more personal objection to the loan. Today, I found an example that fit both.

This loan passed through all of my usual manual filters. A/B grade only, 714+ credit score, debt-to-income ratio < 10%, and zero delinquencies within last two years. The assigned grade was A5, which is quite good overall.

But then I read the details. (If you’re a member, it’s loan #411092.) His reported gross income is $26,000 per year. He’s only been at his current job for only one year. He has been delinquent on accounts before, but last time was over 4 years ago. He has about $18,000 in credit card debt currently. He has 70% of his annual income as debt? To me, that’s like someone making $100k a year before taxes having $70,000 of consumer debt. Seems like quite a burden.

Already skeptical, I then read the loan description. Here it is, after I stripped out what I felt was not important:

This loan will be used to consolidate the remaining balance on two credit card balances and for home improvement. Looking to payoff some credit card debt and add a sunroom to my home. I am coming to the lending club community to help me build a nice sunroom to enjoy a cold glass of iced tea.

Honestly, I didn’t even know what a sunroom was until I looked it up. According to this site, a small 80 sq. ft. sunroom would cost from $5,000 to $15,000. He already has 70% of his gross annual income as debt, and he wants to add another $5,000 to it? That would result in a debt-to-annual income ratio of 90%.

I like the idea of helping people pay down their credit card debt by lowering their interest and consolidating into one payment. But this guy seems to really like being in debt. Now, that’s his choice, but I don’t like the idea of supporting it. Am I alone in thinking this way? I’m thinking I might not be, as his loan request didn’t fund the first time.

You can read about the other details of my LendingClub portfolio here. My annualized return after fees so far is 8.8%.

Investment consultant firm Callan Associates created a neat visual representation of the relative performance of 8 major asset classes over the last 20 years. You can find the most recent one below (click to view PDF), which covers 1989 to 2008. Each year, the best performing asset class is listed at the top, and it sorts downward until you have the worst performing asset. You can find previous versions here.

Lessons Learned?
It is always interesting that us humans tend to try and find patterns in everything. Make your eyes shift out of focus for a bit, and most of the table looks pretty random. What is top could easily end up back at the bottom. Callan says that the table shows the value of diversification.

But I also see some streaks. Let’s look at the white boxes of MSCI EAFA, which is an index following major developed international (non-US) countries. From 1989-1992 it was in the the dumps, and then from 1993-1994 it was tops. Then there are the pink boxes of the S&P 500 Growth. From 1994-1999 it was either 1st or 2nd. For the next 7 years from 2000-2006, it was nearly last.

What do we learn then? Mostly, that there are no reliable patterns. If we simply bet against what was hot last year, we could get burned for 6 more years. If we just follow what is hot, we probably get crushed too. I bet I can guess where most investor money was flowing at the end of each of these streaks…

Also, while the table compares relative performance, you can also note that absolute performance changes all the time as well. In 2008 the “best” asset class only went up 5.25%, while in 1989 and 1995 the “worst” asset class went up over 10%. Sometimes you just can’t win, and other times you just can’t lose.

For the most part, it makes me laugh at all the predictions I hear. We’re almost halfway done with this year. Who wants to guess what the breakdown for 2009 will look like?

Here’s a another little fact from The Snowball that I found interesting. When Warren Buffett set up his first investing partnerships where he agreed to manage other people’s money, he wanted a compensation agreement that was fair and equitable.

I got half the upside above a four percent threshold, and I took a quarter of the downside myself. So if I broke even, I lost money. And my obligation to pay back losses was not limited to my capital. It was unlimited.

The last part meant he could lose more money than he put actually invested into the partnership. He would cover a quarter of all losses from his partners, even if it meant selling his house or other assets. Now that is what I call a true alignment of interests.

Sure, half of the upside past 4% is a lot, but can you imagine any modern hedge fund agreeing to such a fee structure that would expose them to losses? Nope, they get “2+20”, which means 2% of assets no matter what plus 20% of profits, which really encourages them to just swing for the fences. If they implode (which many did recently), they simply pack up and open a new fund down the street.

It’s hard enough these days to find a mutual fund manager where a substantial part of their net worth is invested in the fund they manage.

Since we’re on this topic, I was also notified that brokerage firm Sharebuilder is raising their outbound account transfer fees in mid-June. The fee to transfer an entire account out to another broker will rise to $75 from $50. The fee for a partial transfer will then become $15 per security, with a $75 maximum. They are also lowering margin rates.

So if you’ve been thinking about moving somewhere else, now might be a good time. If you have a small balance, it might be best to simply sell all your positions, transfer the cash out, and close the account. I’ve been thinking about doing this to simplify things. Don’t forget to keep your trade information for tax filing later.

I’ve been meaning to post some smaller updates about my ongoing experiences with person-to-person lending at LendingClub, but I decided to wait and roll them up into one larger post.

Current Portfolio
I now have a total of 32 active loans with $1,122.21 in outstanding principal. Most are A grade, with a few Bs. Here is a screenshot from my account page:

These are the loans that originated after LendingClub completed their SEC registration, which means I can sell these loans on the open market. I also have $91.91 in 4 notes that were pre-SEC registration (these are accounted for separately), all A grade.

Performance
All 32 loans are current, with no late or defaulted loans. I don’t think any have even gone temporarily late. According to LC, my “Net Annualized Return on Investment” based on my interest payments received so far is 8.80%. This is net of all fees. The oldest loans are about 16 months old now, almost halfway through the 3-year term. So far so good.

You can view the statistics for all LC loans here. This study states that as of the end of November 2008, lenders earned an average rate of 9.05%. If you are familiar with Prosper, you’ll note that this is significantly better than their stats. There are several reasons for this, in my opinion. For one, an A grade loan on LendingClub is a lot better quality than an A loan on Prosper. You need to have a 660 credit score as well as other additional requirements just to make their lowest G grade. Also, LC is much more stringent on approving loans. Only about 10% of loan applications are accepted. Their data verification system seems to be more comprehensive and weeds out a lot more questionable and/or fraudulent loans.

Loan Filters / Methodology
For the most part, I only lend to borrowers with a nearly perfect credit profile. I don’t use their PortfolioMatch tool, I handpick each of my loans. It doesn’t take very long; Here’s my basic search filter: A/B grade only, 714+ credit score, debt-to-income ratio < 10%, zero delinquencies, and 50% funding status. The high funding status usually means that the loan has already been approved, with LendingClub verifying enough application information. I check whenever I remember to, probably once every two weeks or so, and if I see something I like, I throw either $25 or $50 at it. My ideal borrower has a 10+ year clean credit history, a stable government job, and is just looking to consolidate debt into a lower rate. Paying 8% APR from LendingClub is a lot better than 10-20% from even the best prime credit cards, and new credit is harder to get now. I like the idea that they can clear out their consumer debt in 3 years or less. Open Market
You can now buy and sell loans, so there is no longer a fixed 3-year commitment. I’m happy with my returns so far, and have not yet tried to sell any of my loans on the open market. I do see that loans with a good payment history of 6 months or so are asking a 4-6% premium to outstanding principal, so it might be a feasible strategy to repeatedly find good loans and sell them after 6 months. You might be able to limit your exposure and still maintain a decent return. (Sellers pay a 1% transaction fee.)

Self-Directed IRA Option
In March, LendingClub announced that you can now hold their P2P loans in a Self-Directed IRA and get the tax benefits. The main downside to this is that you are subject to a $250 annual account maintenance fee. Unless you have a very large amount of IRA funds that you wish to commit to this, $250 is a big drag on performance (1% of $25,000, 5% of $5,000). However, you can also hold other things like real estate or physical gold bullion in this Self-Directed IRA, so it does offer additional flexibility.

Safety of Principal
With the new post-SEC setup, you are now technically buying notes from LendingClub. This brings up the question of what would happen if they went bankrupt. This was previously addressed in my Q&A with Rob Garcia, Director of Product Strategy. In addition to that, I saw on TechCrunch a couple months ago that LendingClub secured another $12 million in Series B venture funding.

$25 New Lender Bonus
If you are interested in lending, you can still use this special $25 lender sign-up link to get a free $25 to try it out with no future obligation. There is no credit check and you don’t even have to deposit anything. After you are approved, the $25 will show up in your account balance, and you can lend it out immediately.

If you’re looking to borrow at LendingClub, my advice remains the same. Send in your information, and see what interest rate they offer you. If you like it, try and get a loan. If your full amount is not funded, you can either accept partial funding or walk away with no obligation.

Postage rates will rise on Monday, May 11th. For example, a first-class stamp will become 44 cents, up from 42 cents. For some reason my Costco keeps reminding me of this, promoting the fact that they are selling a pack of 100 Forever stamps at a whopping 25 cent discount to face value. I thought retail stores didn’t profit from selling stamps?

Forever stamps allow you to buy stamps once and know they’ll be good forever – you never have to worry about future rate changes or buy those annoying 1-cent stamps. However, there is no point in stocking up on them, because Forever stamps are not a good investment. For one, postage rates have not outpaced inflation historically. But more importantly, according to the 2006 Postal Accountability and Enhancement Act, the postage rate will never be allowed to outpace inflation.

It seems the best you can do is by right before the next hike (like right now). I suppose I should just buy the Costco 100-pack and not have to worry about stamps for the next five years or so.

Sources: Slate and Postal Accountability and Enhancement Act

Brokerage firm Schwab lowered the annual expense ratios on many of its in-house mutual funds this week. For example, the Schwab S&P 500 Index Fund (SWPPX), which used to have an expense ratio of 0.36%, now has an expense ratio of 0.09%. That’s just $9 a year for every $10,000 invested. In addition, the minimum initial investment in each of the Schwab Equity Index Funds is now only $100, with no minimum balance requirements.

According to this CNN Money article, “This is not a promotional offer… These are permanent reductions.” This is basically what Fidelity did a few years ago when it lowered their S&P 500 index fund expense ratios to 0.10%, and they have kept it that low since, so there’s hope. Although technically they can always raise the expenses later, I do think ongoing competition will make it hard for them to do so. From the prospectus:

Schwab and the investment adviser have agreed to limit the “net operating expenses” (excluding interest, taxes and certain non-routine expenses) of the Investor Shares, Select Shares and e.Shares to 0.09% for so long as the investment adviser serves as the adviser to the fund. This agreement may only be amended or terminated with the approval of the fund’s Board of Trustees.

Also at 0.09% and $100 to start, there is the Schwab Total Stock Market Index Fund (SWTSX) which tracks the entire US Market (not just the largest 500 or so companies) through the Wilshire 5000 Index.

Schwab Traditional and Roth IRA accounts
I took a quick look at the Schwab IRA accounts, and they appear to have no account fees or minimums. You must initially open with $1,000, but that is waived if you make an automatic monthly transfer of at least $100.

Overall, this is a nice development for smaller investors with Schwab that want to invest in some broad index funds. However, I’ll stick to Vanguard for my IRAs since their fees are nearly as low on the Total US funds, and Vanguard is still much cheaper on all other asset class index funds.