Social lending: Investment amount per loan

Diversification is always easy in theory – invest into as many loans as possible per month and modify your investment amount based on that. This, however, assumes that you have a pretty good idea of how many loans you get into which is pretty difficult to predict, especially with the new bidding system in Bondora.

moneyperloanStarting out

When I started building my portfolio I was quite careful about how much money I wanted to put into the system. This means that I started investing mostly at 5€ per loan. This means that my exposure per loan was as small as possible while I was building up my portfolio, making sure that I wasn’t taking on unnecessary risk. Since I didn’t have a big amount of money to enter the market with at once, then I decided to slowly build my portfolio to reach 100+ loan pieces for a better diversified portfolio. This plan didn’t last long.

Investing such a small amount of money has two problems. Firstly, in a slow market (and there have been months where there weren’t that many investment opportunities) it means that you leave a lot of money sitting in your account waiting for investment opportunities. The second problem being the fact that if a loan becomes overdue then at a 5€ piece it takes forever to get any penalties – I’m quite sure the rounding system of the penalties is skewed towards bigger pieces as well. (This means I think a 10€ piece gets >x2 the penalties of a 5€ piece but I don’t have their calculating formulas to back this idea up.)

Minimal div. rate reached

Once I got more comfortable with the system a few months in, I bumped my investment amount to 10€ per loan for A1000 loans and gave out some lower quality loans at 5€ per piece. Since I added in a fair bit of money at this point then it didn’t take long to diversify my portfolio – by the end of summer of 2013 I was reaching 1000€ in investments, which meant that every investment was 1% of my whole portfolio.

I kept this up quite a while since the step to bigger amounts seemed quite steep – I could generally invest all my money by the end of the month, so I didn’t see a reason to jump to 25€. (Though you can get smaller steps with a script as well.) In theory I was running at a near perfect diversification method – divide up the amount of money you invest per month by the amount of loans you expect to get into – it came out to a convenient 10€ per loan for me.

Time to step it up

I started pondering the jump to 25€ pieces when the market started slowing down the start of this year. If my money hadn’t gone out by the end of the month, I modified my portfolio manager to invest in 25€ pieces. I started seeing the jump in money as well – a 25€ loan which became delayed paid pretty sweet penalties compared to the tiny 5€ pieces that I invested into at start.

I currently have 6 portfolio managers running and I have two of them which are allowed to make 25€ investments – A1000 & B1000 loans. It’s actually working out quite well, since more than 50% of my money goes into these two groups and I let the lesser credit groups get 10€ pieces. This means that I can mostly place all my money while keeping an optimal div. rate. I’m trying to push to increase the amount of money I put in every month and really, once you go over 250€ per month, then the 10€ pieces become silly to chase.

My portfolio has climbed to 2500€+ by now, so 25€ pieces still count for about 1% of my portfolio. I don’t see myself increasing the amount per loan to 50€ at any time soon – firstly, I think I should double my portfolio before that and really increase the amount of money I put in per month – 300€ in investments with a mix of 10€ and 25€ pieces is fine, but a 50€ piece is more than 15% of the amount of money I invest per month. I’ll probably have to reconsider this depending on how Bondora gets their underwriting process to work – I don’t just want to make a huge jump in the loan piece size, because with such a small portfolio it can have a fairly big impact. Overall though, I think my portfolio is going through quite nice organic growth.

What is the Estonian equivalent to a $100 000 salary?

If you read enough personal finance forums then it becomes clear that many people in the United States think that $100 000 is the magical number which guarantees that you don’t have to worry about money. This made me wonder however, what’s the equivalent number in Estonia.

How many people in the US make 100K?

Essentially I did some digging through Wikipedia to verify some numbers that I’ve seen floating around forums. The info is a few years old, but salaries haven’t really increased that much in the past few years so the % of people who receive 100K salaries is unlikely to have increased noticeably. As the US Census Bureau information says, less than 7% of people make more than $100 000 per year.

This salary is generally attributed to only a few fields. It generally includes doctors, lawyers, IT, CEO/COO/CIOs, engineers, bankers etc. This means that it is a salary that isn’t really reachable just through working hard – you have to work in the right field, you have to climb the corporate ladder and it’s also associated with ridiculous working hours.

The Estonian equivalent to 100K

I did some digging in the Statistics Agency web and I looked up information about Estonia in 2010 so it would be comparable. The Agency shows information by deciles, so I can get the number for the top 10% of Estonian salary earners, which will be roughly usable. As it turns out, the top decile of Estonian salary earners make 1400€+ per month. Average salary in 2010 was 820€. Currently it’s 986€, so a 20% increase. Assuming that the top 10% have increased their salaries 20% as well then the cutoff would be 1680€, if their salaries have increased by 30% then it would be 1800€+.

Honestly? I was very surprised. I expected it to be way higher. Even a 1800€ gross salary is 21600€ per year – only roughly $30 000! Also, a 1800€ gross salary comes to less than 1400€ net. I’m not even sure what to conclude from that. One thing that would make sense is that the salary inequality is a lot lower in Estonia than I assumed. It might also mean that it’s just the top two-three deciles which are closer to one another than I expected.

I definitely agree that looking at the current situation in Estonia a 1800€ gross salary wouldn’t really force you to worry too much, but overall it’s way harder to build wealth on a salary like that than it is with a $100K salary in the US. This leaves a bleak conclusion – becoming rich in Estonia just off your salary is a ridiculous dream.

P.S. If anyone can dig up more recent statistics about Estonia, I’d be happy to hear them!

Social lending: The importance of diversifying your portfolio

When a person starts with social lending then there are several key topics that constantly get mentioned and the importance of diversification cannot be overemphasized by most investors. However, how exactly does diversification work? How does it lower your risk and how should you diversify your portfolio?

diversification – Investopedia defines this as a risk management technique that mixes a wide variety of investments within a portfolio.

With your overall investment portfolio this would be demonstrated by investing into stock, real estate, bonds, P2P lending, precious metals etc. Within your social lending portfolio this means both increasing the amount of unique investments that you have and varying the type of investments that you have in your portfolio. Ideally you should mix both for best results.

How many investments are enough?

Both Prosper and Lending Club have their own set of suggestions about this, but the ballpark number is that you should have about 150-200 investments in your portfolio. The reason for this is that the bigger the amount of investments, the less importance a single investment carries. For example, if you invest 1000€ in 100€ pieces, then each piece counts for 10% of your portfolio. If you invest in 20€ pieces then each piece counts for 2% of your portfolio. It hurts your returns a lot less if one of your 50 loans defaults as opposed to one of your 10 loans defaulting.

People have all sorts of unexpected problems all the time that manifest in their inability to fill their financial obligations. The more different loan pieces you have in your portfolio the safer you are to random movements in the job market or financial markets. Of course, you should take a pick as to what kind of loans you invest into, but up to a few hundred loan pieces having more investments is always better than having less. Once you’ve hit I guess about 500-1000 loan pieces then the importance of diversification in terms of the number of loan pieces drops off quite suddenly.

Essentially there are two ways of achieving this type of diversification. Firstly, you either buy a lot of loans from the secondary market on entry to quickly increase your diversification rate or the other option is to just steadily invest until you have a well balanced portfolio. Currently my portfolio has about 300 loans in it, which means that each individual loan only carries the weight of about 0,3%.

What type of investments should you have?

This is where the diversification strategy that I use gets a bit more complicated from both a philosophical and a rational standpoint. A lot of new investors only want to invest in high grade loans. (In the case of Bondora, those being mostly A1000.) The problem with strategy being the fact that you don’t get all that many loans since everyone wants the best credit grade loans. Something, however, that quite often doesn’t get mentioned is that only forcing investments into the premium credit group actually hurts the diversification or your portfolio.

A look into what the actual credit grades mean demonstrate how this problem comes about. Investing into one credit group also exposes you to one type of people. There are quite clear differences in what kind of people get into the A1000 group in Estonia. You can’t really get there with a low paying job that isn’t in one of the more important fields like tech, law, production, business etc. Investing into the same type of people also means that if a recession were to hit the economy, there are always certain fields that get hit very hard as well.

The recession, that some say is still ongoing, was a great demonstration of how having a good credit rating didn’t mean much in the end. One of the first people to get laid off were all kinds of office workers who tended to have quite well paying jobs and they ended up struggling quite quickly because they were just that used to always having money. On the other hand, people like plumbers, mechanics, teachers, assembly line workers, office managers and other mid-pay jobs were quite safe due to the constant demand that exists for these jobs. Investing into a variety of credit groups also means that your portfolio includes different kinds of people who live in different areas and have different jobs, which makes you less vulnerable in case of a recession.

My diversification strategy in 3 steps

1. Include at least 200 individual loan pieces into your loan portfolio (I currently have about 300).

2. Diversify across different credit groups to minimize risk (I aim to have about 20-25% of my portfolio NOT in A1000 loans).

3. Keep increasing the number of loan pieces you own while keeping the type of loans within my set parameters.