Of portfolio balance

There are many different portfolio balance theories out there in the world of personal finance. Some are based on risk management, some based on diversification, and some have a logic so complex that it takes a while to even figure it out. Whichever portfolio strategy you use, one idea is constantly emphasised – you must diversify between different asset classes and markets.

Why diversify across asset classes?

The somewhat classical theories focus on three main asset classes – stocks, real estate and loans. Other options include metals, entrepreneurship etc. The idea behind diversifying asset classes is that they behave differently in different market situations. While stocks can be quick to drop, they can also generate incredible short term returns and are considered relatively stable long term.

With real estate the main value is the idea that you own a physical asset – while a company may go bankrupt then you still own an apartment or a house and while it may drop in value, it won’t completely drop to zero. Real estate and loans also help generate cash flow in a way that stocks generally don’t.

This means that to reduce risk levels you should have different asset classes in your portfolio because in case one asset loses value the others may keep theirs for longer. In the case of a big economic crisis of course all parts of the market drop, but different asset classes recover at different speeds and being able to generate cash flow while you wait for capital growth recovery is valuable.

Why diversify across markets/geographically?

In the case of social lending diversifying across hundreds of loans helps you manage risks by betting on the fact that not all regions of the country lose jobs at the same rate. In case of a crisis it’s clear that the less wealthy regions of Estonia will be hit harder while the bigger cities are likely to have more job opportunities therefore people will be more likely to pay back their loans.

For stock markets geographical diversification in its broadest sense means picking different markets. I invest both into the Baltic market and into the US market. Maybe soon I’ll add in general European markets as well. The benefit of this is easy to see – if you take side by side the growth charts of Europe and USA, then you can clearly see that they don’t always move in a similar direction, which means more stability for your portfolio.

Why diversify across different risk classes?

Everyone who invests wants high returns. It is however important to keep in mind that higher returns are linked to higher risks as well. This means that while you may enjoy higher returns when the market is climbing upwards then higher risk investments also mean a much bigger hit when the market takes a steep downwards turn.

Generally stock indexes are considered much safer than individual stocks due to the lowered risk provided by higher diversification rates. Social lending is inherently riskier than real estate backed loans where you have less of a chance of walking away empty handed.  The same way smaller apartments close to city centres are generally considered lower risk since they’re likely to maintain renters’ interest even in the case of an economic downfall.

How to assess your portfolio?

The easiest way to look at whether your portfolio is balanced is to either write it down in numbers or have a visual outline of your portfolio. Taavi I. wrote a nice piece of code that allows you to visualise your portfolio and I must say I quite like the visual aspect of it.


For example the image above is the balance of my current portfolio. It lists all social lending, stocks, indexes and crowdfunding. As you can see, my portfolio is very heavily influenced by whether or not Bondora does well (Bondora used to be 75% of my portfolio) so I’ve been working hard to push it down to 50% overall portfolio value.

Ideally your portfolio should be close the 1/3 in each asset class. In my case what is arguably missing is real estate (since Crowdestate is not pure real estate), which is why I set the goal of getting into rental real estate this year. Overall though, you can see that my portfolio is getting better in terms of overall balance. While my portfolio isn’t all that big yet, then getting into the habit of it being balanced will help a lot in the long run.


Understanding social lending returns

A problem that’s been popping up more and more when people discuss social lending is that some people who have experienced some loans going bankrupt are creating a lot of panic about social lending making you lose money. This causes quite a lot of questions about social lending returns that I often have to answer, so I thought I’d go over some frequently asked questions.

How do I tell how much money my social lending portfolio makes?

There are many different “axe” methods that people use. Looking at defaults vs interest earned, looking at interest earned vs portfolio value and any other super simplistic methods. While those can give you relevant feedback about your portfolio in some cases, the only 100% sure way to assess your returns is calculating them yourself using (X)IRR.

This means that you have to use Excel or another data analysis program and run through the numbers yourself. I regularly go through my portfolio returns like this to see how my portfolio is moving.

What about the defaulted loans?

At start defaulted loans hit very hard. If you’ve just started with small amounts then you might not have even made 10€ in interest by the time the first 10€ loan piece has defaulted. This doesn’t mean you’ve made a loss yet – until you’ve made an exit any and all losses are theoretical. This means that unless you sell delayed loans before they default you have to wait for recovery to begin to meaningfully assess how they impact your portfolio.

After two and a half years of investing only four loans so far have made a complete recovery in the value of principal owed with about a dozen others slowly making payments. This means that I’ll be able to assess how well my first loans have recovered by the end of 2016 – and some may not have recovered at all by that point.

What creates high returns for social lending?

The main concept you have to understand when investing into social lending is the fact that your returns start to stabilize as time goes on. The money that gets paid back gets reinvested instantly helping create more returns every month. This means that after a while you start seeing the classical growth curve that starts to curve up more and more due to compound interest working in your favour. This effect is difficult to see if you’re just starting out or your portfolio consists of a small sum of money only.

How to avoid losing money in social lending?

Every investment decision has to be based on a strategic decision. Many people invest into social lending just because it sounds good and its currently popular instead of actually having a strategy or doing any calculations whatsoever. With social lending there are several key points you have to take into account when building your portfolio.

Firstly you need to diversify to at minimum 200 loan pieces as quickly as possible while 500 loan pieces should be your goal. Secondly, the more risky loan groups you invest into, the longer your investment period should be due to the impact of recovery on your returns.

How do I know that my portfolio strategy is working?

Provided that you’re constantly investing you need to also constantly keep track of your portfolio. This means either XIRR, following the growth of defaults and comparing them to site provided averages, assessing interest growth in comparison to portfolio size and other such metrics may be used.

Not a single investment works without additional care, especially not one like social lending that’s new enough that it doesn’t even have a decade of history yet. The credit ratings, the portfolio managers and the overall logic is likely to change, which is why it’s important to keep track of changes.

Do your own analysis, read blogs and newsletters or have an investment group or whatever else necessary. Social lending was and still is a high risk investment, and for that very reason you can’t invest passively even though it’s super accessible to everyone it’s not for everyone.

Reducing the risk of my Bondora portfolio

The new Bondora rating system has been live for almost four months now, and it’s time to see how my portfolio has changed. I set out to slowly start to lower the risk of my portfolio for two reasons. Firstly, because the lack of the country filter means that allowing in all risk groups in my opinion isn’t reasonable and secondly since my portfolio is getting bigger, then I’d like to make the portfolio a bit more stable as well.

At the end of November this is what my portfolio looked like:


Even though by the old logic 50% of my portfolio consisted of “good” A1000 credit group loans, once the new ratings were added, the picture completely changed. This is why I decided to try to slowly reduce the amount of risky loans, only adding them on manually and allowing the new portfolio bidder to invest into AA, A, B & C loans. The results have actually been less dramatic than you’d expect.


The actual changes are as follows:

AA (0%), A (-1%), B (+3%), C (+4%), D (-3%), E (-1%), F (0%), HR (-3%)

Now, the question is, why are the changes so small? Four months should be a reasonably long time. The answer consists of many components in this case.

1.) There are very little AA and A loans, and my portfolio had more than the marker average for both. This means there just aren’t all that many loans for me to add into those categories even if I want to (I have 1,2% of AA loans while the historical average is 0,3% and I have 6% of A loans while the historical average is 2,5%)

2.) Since E,F&HR credit groups include a lot of my defaulted loans (440€, about 70% of my defaults), the principal amount of those groups is slow to change, because loans in other groups are getting paid back and reinvested, while there is a lot of locked in principal in those groups.

3.) Since my portfolio is at just about 5500€ currently, then to meaningfully change the balance of different credit groups take quite a lot of money to see the impact. At the rate I’m going I’ll get the HR rate to drop to about 12% and about 4% for E&F by the end of the year since I haven’t completely stopped investing into those groups.

This demonstrates very clearly why it’s important to have a long term strategy for your portfolio. If you just wish to change things quickly, then it won’t really work in social lending. The 600 or so loan pieces that I had before I started to slowly lower risk levels will impact my portfolio for a very long time, and to completely overhaul my portfolio I’d have to sell a lot of loans (which I don’t want to do).


My Bondora portfolio (2015, March)

March was not a particularly good month in social lending because the new changes to the system of giving out loans meant that a lot of money was stuck under bids and bounced back, so the amount of loans given out was relatively small.

Another issue, that I just came across last night when I tried to start writing my portfolio summary was the fact that Bondora has once again managed to break something, making the numbers I see under investments not match up to what the graphs show.

Essentially, when looking at the investments page I see that I gave out 365€ worth of loans in the month of March. However, looking at the numbers on the statistics page, this is what I see: what1

So, the charts say 410€, which is 45 euro difference. When looking at bids and free money and any other combination of numbers, the differences don’t work out. I sent the report for the bug as well but not as if I’m actually expecting Bondora to fix this. Their graphs have been terrible for a while, so this is another one becoming useless. Seems like it’s time to just look at the numbers given in the csv files, because the other info is just terrible. (Edit: Apparently it’s some dumb issue with time ranges – the csv is correct when you pick 1st-31st of March, but to get the same numbers from investments page you need to pick 1st March-1st April.)

So, believing to trust the investments page (which is also problematic, since I have a bid on a loan from 5th of March that I’ve been told is an actual bug now that hasn’t been fixed in a month) then March was a relatively slow month.


The only positive thing about this month I suppose is the fact that not that many defaulted loans were added. One loan had its principal fully recovered, so it’s at least good to see that something is happening in terms of the 60+ loans. However, since a lot of the paid back loans are still show in the pie chart as green, then visually this chart is also becoming more useless by the day.


In terms of interest earned, March wasn’t as successful as I hoped. I wished to be closer to the 100€ marker, but the month ended up at 94,65€. April isn’t looking too optimistic either since a lot of money spends a week sitting under bids, which seems a bit too long. Hopefully that will improve. The 100€ goal seems to be realistic in May though.

Loans given out

In terms of new loans added, a lot of the A group loans that I got bids into were canceled, so the overall total of loans given out was smaller than usual and very many loans went into group C that is starting to make up a bigger and bigger part of my portfolio. I only had a chance to pick some loans manually, since a lot of the ones that I did pick ended up being cancelled anyways. I hope next month is a bit more balanced and for a change maybe some things on the site get fixed?!

(EDIT: I finally found the missing 45€ worth of loans, so the total of loans given out is actually 410€, but the investments list just doesn’t show it.)