After four years of record low interest rates the people who have been hardest hit are retirees. Traditional investment theory suggests that these people should have a large segment of their portfolio in fixed interest. But a mix of corporate, municipal and government bonds are yielding in the low to mid single digits, not nearly enough for most retirees to live off. What is a retiree to do?
There is a relatively new investment that has been gaining in popularity the last few years called P2P Lending. But surely p2p lending is too risky for retirees who should be taking fewer risks at this stage of their life. While p2p lending is not without risk a small portion of a portfolio invested with one of the two leading companies, Lending Club or Prosper, can really help retirees.
Let’s take an example of a typical retiree. John Doe is a retired 65 year old with a $1,000,000 nest egg that is invested in 70% fixed income/30% stocks. For this example we will assume a good portion of this money is in a retirement account such as a 401(k) or IRA.
The way p2p lending works is that borrowers make principal and interest payments every month so investors can withdraw more than just the interest payments. It can operate like a short-term annuity.
Here is what John Doe does. He rolls over $100,000, just 10% of his nest egg, into an IRA at Lending Club or Prosper. He invests in a medium risk portfolio of three-year loans (called notes) that has an average interest rate of 14%. Defaults and fees will likely mean an average return of 8-9%. But John is treating this investment as a short-term annuity and he will be withdrawing principal and interest payments every month.
With his $100,000 investment he will receive payments of between $3,500 and $4,000 per month – it varies each month because some borrowers pay back their loan early and there will occasionally be some defaults. He can then withdraw that money to live off for three years and then he can repeat the cycle. Towards the end of three years he takes another $100,000 from his portfolio and rolls it over again.
Lending Club and Prosper make managing an investment like this very easy. Both companies provide an automated way to invest. For Lending Club they have a PRIME account and at Prosper it is called Premier. These services allow investors to choose their level of risk and leave the actual investing in borrower loans to an investment team.
Of course, John Doe may decide he doesn’t need to withdraw his entire cash balance each month. P2P lending is flexible in this way. He can choose to allow the cash to stay in the account, in case he might need it next month, or he could reinvest the money in new notes. By reinvesting even a portion of the p2p lending portfolio the money will have a chance to compound at a high interest rate.
Alternatively, he may decide one month that he needs more money. P2P lending companies have trading platforms that allow investors to sell notes for a small 1% fee. This allows investors to liquidate their portfolio quickly and turn their notes into cash.
John Doe may have some other income coming from the rest of his $900,000 portfolio as well as some social security income. But with this strategy he will be able to repeat this process every three years for the rest of his life (or at least 30-40 years) and be able to produce returns well above inflation.
Of course, an investment in p2p lending is not without risk. A deep recession would likely cause an increase in defaults that would impact returns. But with conservative underwriting at Lending Club and Prosper these days it is unlikely that returns would turn negative. Given the history of 2008-09 we certainly couldn’t say the same thing about the stock and bond markets.
Retirees have been starved of yield for too long. With no end in sight to this low interest rate environment, investing with p2p lending is something worth considering.
Peter Renton is the publisher of the Lend Academy blog, the most widely read blog on the topic of peer to peer lending. He has been an investor in both Lending Club and Prosper for several years and enjoys a double-digit return on his investments. He is the creator of the online video course, the P2P Lending Wealth System and also the author of the new book, The Lending Club Story.