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.

Things I wish I had known when starting with social lending

Last night the Women’s Investment club met again and this time our topic was social lending. Since most of the people who came to the even didn’t have much (or any) experience with social lending, I had to really go back to the basics when preparing for the meetup.


How to start?

This was one of the most popular questions – how to get started in the technical sense (as in, how to make an account, how to make portfolio managers) but more so, how to start with the actual investing – which loans to pick and how.

1. I wish I had known to worry a lot less about credit groups and returs and other numbers back when I didn’t really understand how they worked. It’s super easy to get caught up in all sorts of Excel tables and graphs and analyzing your return numbers, but it’s just not all that useful when you lack fundamental knowledge about how the sector works.

2. I wish I had started both earlier and with bigger amounts of money. Even if I had made the same mistakes or more mistakes at start, I would still be enjoying far bigger compounded returns at this point. I spent way too much time paying attention to how my very small portfolio was doing as opposed to focusing on how to increase it.

3. I wish I had found people who shared similar interests way back when I was starting. It’s been pure chance that I stumbled onto other people who shared an interest in social lending, and I think we have all learned a lot from each other’s ideas and thoughts. In that sense all the women in our investment club are super lucky – there is a lot of knowledge on offer if you just ask.

What to do if you’re just now starting?

1. Make your first 1-5 small investments into Estonian loans and just follow their progress and assess your risk tolerance based on how nervous you get and how often you log on to check on your loans. (Spending time on reading up on theory will not give you any extra magical returns on these first investments.)

2. Focus on increasing your savings or your income to be able to invest more money monthly. With social lending every 5 euros saved will help! Once you have some money in your emergency fund then start planning for how much money you want to invest into social lending each month.

3. Read up on some of the wealth of knowledge that has been written about social lending in the past few years. Look at blogs that show real numbers so you can estimate what your portfolio will look like in the future. Don’t get too carried away with this – it isn’t worth reading 5 hours if you’re investing 100 euros.

4. Find an investing buddy! This is super important because having a friend with similar interests will both motivate you to keep going, you can share interesting bits of info and learn from each other’s mistakes. Going to different meetups to hear other people helps you keep track of what’s happening as well.

5. Focus on slowly increasing your portfolio while keeping in mind that your first priority is to diversify your portfolio to at least a few hundred loans. Get a feel how different risk levels work for you – it’s ok to make small investments into riskier loans if you want to try them out. Just keep in mind – the closer you keep to “boring” investment strategies, the more stable your returns.

Happy investing!