When I search through listings on Prosper, I generally look for loans from borrowers who have really taken the time to give Prosper lenders a good understanding of their financial situation and the purpose of their loan.

After I bid on a loan, I tend to feel so confident that they are trustworthy and credit worthy – I think to myself, “they’ll definitely pay me back.” 

But it isn’t as simple as that. Even in rare occasions, the best borrowers can have a huge cost overrun on their home improvement loan. Or their business expansion loan might not be working out, even though everyone agreed the plan was solid.

How can we lenders protect ourselves from losing our money on these seemingly wonderful listings with compelling reasons to bid? Diversification.

Diversification is considered one of the only “free lunches” in finance. It was a concept that changed Wall Street and markets, because for the first time, people realized they could lower risk without lowering expected return. 

How might that work on Prosper?  Instead of committing $1,000 to one loan, spread it out. Make 20 bids at $50 each.

In fairness, there’s a good probability that one or more of those 20 loans will have a late payment and maybe (though hopefully not) a default. But even if some of your loans don’t work out the way you wanted it to, your risk is spread around. Losing out on 1 or 2 will be trumped by the rest of your loans performing as expected.

The more you diversify, the more your portfolio’s expected return will be close to your actual return.

In addition to bidding in smaller increments, here are some other ways to diversify using Prosper:

1) Set up a recurring transfer.
When transferring funds to Prosper, I like to transfer $250 a month, which I can do automatically on the transfer funds screen. Bidding a little bit each month helps to resist the temptation of bidding big on one loan.

2) Re-bid your payments.
Every month when my borrowers make payments to me, I put my money to work by using them to bid on new loans, which further helps to diversify the collection of loans I own.

3) Create a custom portfolio plan.
Creating a portfolio plan that fits the criteria of loans you like to bid on saves a lot of time. Prosper will search for the loans that fit your portfolio plan and automatically bid on the listings that meet the criteria you set. 

All of these are great ways to make sure you are diversified rather than putting all of your eggs in one basket. Enjoy your free lunch.

-
Rohit C. has been a Prosper member since April 2006.

My job at Prosper is to show lenders how to use Prosper and its various bidding tools. I speak with dozens of new lenders at Prosper every day. I often share the learnings of successful lenders, as well as the teachings of the marketplace results.

One of the most critical messages I try to share with lenders is to slow down and bid methodically rather than try and pump out 25 manual bids in a single day. Diversification is usually the next topic that I discuss with lenders. Not simply bidding in small increments, which is important, but also diversifying across credit grades and especially loan amounts.

Some users naturally don’t have the time to spend bidding slowly across many listings, in which case I show them how they can create a Portfolio Plan or employ a combination of manual bidding and portfolio plans simultaneously.

While I understand that the idea of Prosper is really exciting, and combined with the prospect of great returns it can be tempting for lenders to deploy their cash as quickly as they can bid it out. However, bidding and being a successful lender on Prosper is more often a marathon and not a sprint. Furthermore, as a new asset class it deserves some time to be researched and understood. Undoubtedly, we’ve all bid on some listings early on that we look back on and say “if I knew then what I know now, I would have never bid on that listing”.

Get comfortable reading the Credit Profile of every borrower you’re considering bidding on. If you’re wondering why a borrower has 8 inquiries in the last six months use the Q&A feature to ask the borrower. In fact, I personally ask ALL borrowers at least one question before I’ll place a bid on their listing. This is an excellent way to get clarification, additional information not in the listing and to gauge the responsiveness of the borrower.

We have a wealth of information available in the Help section under the Lending topic.

And you can always call or email us questions. We’re here to help you.

Kiplinger’s recently published an article about Prosper entitled “Risks and Rewards of Online Lending.” The article addresses the expectations Lenders should have with regard to interest rates.

“Lend to a borrower with bad credit and you can expect a higher interest rate. A borrower with a better credit history will get you a lower rate”

Generally speaking, the lower the borrower’s credit grade, the higher the risk and the more volatility you should expect.

In order to earn a risk-adjusted return, you should account for risk when setting your bid amount. For example, credit grade D borrowers generally have higher expected losses than credit grade AA borrowers. This means you should expect a higher level of return on a D listing than on an AA listing to compensate for the higher level of risk you are taking.

A number of members were interviewed for the article, one being Alex Clemens, President of Barbary Coast Consulting.

In the case of Alex Clemens, a lender on Prosper, his average interest rate on his loans is around 13% and he estimates he is getting an annual return of around 8%.

We talked with Alex today about his estimated return and I quote:

“When the reporter and I chatted, she asked me what my expected return was. This spurred a conversation about the potential for What Happens When Borrowers Do Funny Things, and after talking for a while, I told her two things – my average interest rate on my loans was somewhere around thirteen percent, and my expectation was that after late loans and defaults were factored in and all was said and done, I was hoping to gain an annual return of about eight percent on my Prosper loans.”

I clearly confused the reporter by talking about the two different rates. But now, with the article in print, I figure that there’s a real risk that some people might (a) call me out as a self-important fraud for claiming a much higher return than is realistic, or (b) encourage me to start an investment firm and give me their life savings to achieve a thirteen percent return. And while (b) would be kind of fun in the short term, I’d kind of like to avoid both outcomes, as I have a day job.

In order to assist Prosper lenders understand how loans with certain characteristics can be expected to contribute to their portfolio return, Prosper has an estimated return tool. The estimated return tool allows lenders to see a projection of credit losses and returns based on the actual performance of the loans to date. The tool is designed to help lenders understand the risk and return characteristics of loans that are similar to listings for which they are considering placing a bid.

There are four components in the average annual return – average balance, net interest yield, net charge-offs, and servicing fees.

As Alex points out:

“Everyone’s Prosper experience is slightly different from everyone else’s. We all understand the risks and rewards of participating in this small-d democratic form of participatory, community-based lending. Some do it more for the social aspect, and some more for the financial upside.”

Gymnastics gold, silver, and the fabulous one two of Nastia Luikin and Shawn Johnson inspire this week’s roundup.

To start off CNN Money writes 17 ways to raise fast cash; of course there is a catch. This is a list of the 17 worst ways to raise the money even though each item does include a pro except number 17. Borrowing from mom and dad is the only one without a hard con.

Eat out like you used to and still save money at restaurants. Lazy Man and Money shows you how with these ten tips.

Rich Credit Debt Loan writes this week on what you need to know before buying a foreclosed property.

Would you prefer a four day work week? Cash Money Life explores the pros and cons of this new schedule. What say you?

Generation X Finance posts two-thirds of corporations don’t pay taxes - nothing more than political hogwash . The post goes into depth explaining business operations and taxes associated with companies.

Digerati Life looks into the best company to work for: money and perks like no other. Can you guess the name of this company? Hint: You access this company everyday.

Brip Blap blogs on the truth about passive income—it’s more humorous than anything else.

My Dollar Plan goes over 7 Sneaky Ways Your Health Insurance Can Save You Money.

Photo Credits: 1

RateLadder is a Prosper lender and has been since July, 2006. He has a passion for p2p lending. He owns RateLadder — My Prosper.com Journey and other P2P Lending Adventures, P2P No Bank the P2P Blog Aggregate, and ProProsper — Professional Tools for Prosper Lenders featuring SQL access to Prosper data.

I have always loved magic. As a kid I was amazed at how the magician could make a beautiful lady disappear and reappear in a different outfit or cut her in half and put her back together. My favorite trick is the one where the magician is able to pull deck after deck of cards out of thin air, fan them out, and toss them to the ground and pull more cards out of nowhere. I used to buy books and videos on how to perform my own magic. I even learned how to levitate a few inches off the ground. So how are these tricks performed? Well, few magicians may really have magical powers, but most others magicians practice the secrets of illusions and sleight of hand. The key is knowledge and practice.

After working at Prosper for over a year and a half, I have seen many borrowers hope for something magical to happen to their listing without any knowledge of how to get funded. But just like a magician, you’ll first need the knowledge and then go and practice it. It does take some time and practice to create a good listing.

Some things to remember when creating a listing:

1. Include a meaningful picture: A picture is worth more than a thousand words. When I was a child my favorite books were the books with the most pictures. People like pictures and if they like your picture, you might win that bid.
2. Include a description that makes sense: Everyone already knows you want the money, so this is the place to explain the reasons why. Make sure everything you explain makes sense.
3. Double check your grammar and spelling: Your teacher is not going to grade your listing, but lenders are going to make assumptions based on what they see. If your listing looks like it is well organized and well thought out, then that reflects the type of borrower that created the listing.
4. Answer lenders’ questions: If any lender took the time to ask you a question, they must have some interest in your listing, so reply promptly with an honest answer and you might win that bid.
5. Get recommendations with bids from friends and family: Just like in the real world, a few good words from a good reference will help build trust and narrow the gap between two strangers. Recommendations are strong because actions (money) speak louder than words.
6. Loan Amount and Interest Rate: Prosper listings with low loan amounts are funded more often than listings with high loan amounts. So if your loan amount is too high you might want to try lowering it to attract more bids from lenders. And increasing your starting interest rate may attract more bids and drive your interest rate down!

With these secrets, you too can now perform some Prosper magic. Voilà!

-

Alex Hung is a member of Prosper’s Support Team