Investors often ask, “How much diversification is optimal when investing with Prosper peer-to-peer lending?” Based on our analysis of Prosper Notes (using data we make publicly available), investing in Prosper yields positive returns with 100 Notes or more*. And the power of diversification doesn’t stop there. Portfolios with larger numbers of Notes also benefit from higher, more predictable returns and lower volatility.
Seasoned Returns Data Exhibit Positive Returns for Diversified Portfolios
As exhibited in the table below, every Prosper investor account with a portfolio of 100 or more Notes (where each Note is a unique loan) purchased since July 2009 experienced a positive Annualized Return on investment.
While accounts with less than 100 Notes had a weighted average return of 9.9%, this segment also experienced large losses and a wide range of investor returns. Dissecting this segment further, as exhibited in the graph below, the largest losses and widest swings were incurred by accounts with less than 20 Notes. At less than 100 Notes, 8.7% of accounts experienced losses, in contrast to 0% of accounts with 100 Notes or more. As to be expected with the effects of diversification, the range of returns (minimum vs. maximum) tightened as the number of Notes increased, thereby producing positive and more predictable returns.
Diversification Delivers Lower Volatility, Meaningful Returns
In practical terms, the data suggest that to benefit from broad diversification, accounts should have at least $2,500 for investing in a minimum of 100 Notes. (Prosper’s current minimum investment amount is $25 per Note.) As the number of Notes increase to several hundred, broad diversification pays off in lower volatility as well as meaningful positive returns.
Prosper has long advocated for broad diversification across a large number of Notes to help reduce risk. It’s difficult to predict the default risk of a solitary personal loan despite our practices of strict credit policy, borrower qualification and loan verification. But when investors spread the risk across tens or hundreds of loans, default risk is more manageable.
This idea, albeit somewhat simplified here, is a cornerstone of modern investment theory. Like spreading investment risk across stocks of many different companies and industries, peer-to-peer lenders should also invest in a meaningfully large number of Notes to reduce the volatility of returns and optimize their probability of attractive returns.
If you’re new to Prosper and seeking predictable returns and higher yields, open an account today, or call us at 1-877-646-5922.
*Includes all accounts with purchased Notes between July 1, 2009 – January 4, 2011 which do not have any participation on the FolioFn trading platform. To calculate Annualized Returns, a total gain or loss is calculated by summing all loan payments received net of principal repayment, credit losses, and servicing costs. The gain or loss is then divided by the average daily amount of principal outstanding to get a simple rate of return. To annualize that rate, we divide it by the dollar-weighted average Note age of the Notes in the account (calculated in days) and then multiply it by 365. Accounts with returns less than -100% (due to annualizing formula) were set to -100%. Dollar weighted return for each loan grouping was calculated as follows:
1. Aggregate the average daily balance for all accounts in each loan grouping.
2. Divide each individual account’s average daily balance by the aggregate average daily balance of their respective loan group, obtaining a ‘dollar weight’ for each account.
3. Multiply each account’s annualized return by their ‘dollar weight’ and then sum across the loan grouping for a dollar weighted average of the entire group. Example: SUM(( Individual Account Average Balance / Aggregate Average Balance ) * Individual Account ROI)
All calculations made as of November 4, 2011. Annualized Returns not necessarily indicative of the future performance on any Notes.
Notes offered by Prospectus.