The following is a guest post from Financial Samurai reader, Jeremy Johnson about earning 10% returns in passive income with P2P lending. Jeremy was kind enough to help me out with a random WordPress question issue when I first started back in 2009.
Peer to peer lending is one of the most simple and effective ways I've ever found to make passive income. It has outperformed my stock picks, selling old baseball cards, my own business ideas – everything.
I've earned more money through it than I've earned at anything else except my day job. This is pretty powerful for me. I'll share a walkthrough of how this works for me and you can use/adjust for yourself.
At the end of this post, I'll highlight my favorite passive income source that is even better than P2P lending.
Prerequisites To P2P Lending
There's some qualifications to use peer-to-peer lending such as being in a state that allows it, and having a certain level of verified income in different states. Usually it's $70,000 a year or more in income.
My state, Utah, has no such requirement. I think most readers of Sam's website will make the income cut – you'll just have to live in a state that allows you to invest. Beyond that, you just need a bank account of some kind – online, credit union, etc…, it doesn't matter what kind of account it is.
Getting Started With P2P Lending
I was most interested in how I could use Prosper.com and spend as little time as possible on the site. Hey, I'm lazy and I like things to be automated. When I started over 2 years ago, only Prosper.com had automated investing. Lending Club hadn't joined the band wagon yet, but now it has.
When I saw automated investing on Prosper.com, I was immediately hooked. I dumped $10,000 in and input my first set of criteria and Prosper.com picked the notes for me to invest in while I slept. It was great.
How Do You Earn Money?
Prosper.com is essentially a crowd lending website where you become someone who loans out money and you get paid interest. Isn't that cool? You're like a bank now, getting paid interest. It's an awesome feeling to be the lender instead of the borrower. You invest in portions of loans.
If someone on Prosper.com is asking for a $10,000 loan to consolidate their credit card debt, you'll more than likely not invest nearly that much. You'll invest in part of the loan – maybe $25, $50, or $100. This is called a note. Lots of people will help this person get that $10,000 loan.
And that group of people will then be the lenders of that $10,000 and when that happens, the loan will be funded and interest payments will begin. When it comes time for the borrower to pay interest each month, you'll get a portion of that interest.
Can You Lose Money In P2P Lending?
Yes, you can lose money. Like any loan, the person who got the loan could get sick, hurt, have bad luck, be irresponsible, or just plain decide not to pay anymore. If this happens, it is called a default.
Prosper.com will try and get that person into collections, but more than likely, the only money you'll get is what has already been paid in interest. The rest would be a loss to you.
Fortunately, at this time, far more people are making their monthly payments than are defaulting, but who knows, this could change in the future.
How Do I Get 10% Returns With Prosper?
The way I get 10% is very simple. I use the automated quick invest feature of Prosper.com. I have three categories: Low Risk, Medium Risk, and High Risk. Each loan in Prosper is assigned a rating, from A to E.
There's also a High Risk category, but I won't get into that. A's are the least risky – people with great credit and other things going for them, and E's are the most risky. However, the E's pay the most interest back to you and the A's the least, so there is that to consider when looking at what notes to get. Most of my notes are $50, with some being $25 and others $100.
P2P Lending Loan Choosing Strategy
My strategy to start was to get A, B, and C loans in an equal amount. Prosper.com tells you the average returns for their notes. However, I like to look at my account and see what each loan category is returning. Each month I look to see what note letter returns the most. I then set my automated loans to invest in those.
My High Risk category is D and E loans only. Medium Risk is B and C, and the Low Risk is A and B. This means I can toggle where my interest goes quickly if one note category is outperforming another. Right now, the high risk notes are returning the most, but that could change as I invest more into them.
As a side note, Prosper.com takes a small percentage of the interest (around 3%) earned on each loan – that's how they make their money. So if you are paid interest on a note for $1.00, Prosper.com will take $.03 and you will be left with $0.97. Not too bad at all.
As a side note comparison, App developers on the Apple store get charged a 30% fee on every transaction where they earn money. Therefore, I consider 3% very generous. I came up with 3% after looking at my interest payments and seeing the Prosper.com service fee and just doing a percent calculation of that based on the interest paid.
P2P Lending Performance
The key values here are my account value, which is $38,259.11 and my annualized return, which is 10.58%. This is the best return I've ever had in investing. As time goes on, I'm going to try and maintain this return by investing in notes that return higher than 10%.
Right now, that is C, D, E, and HR loans. As my account balance grows, I believe I'll have to change from investing $50 per note to more like $100 in order to continue to get notes with my extra cash, but time will tell on that.
Here are my portfolio details:
I've got 910 notes and quite a high level of diversification across notes. I'm sure I could do better at screening notes, but my philosophy is to just go where the returns are and invest in those notes. I care about my time, so spending time screening each note or loan is not something I'm interested in doing at this time.
I have a 5% rate of notes being late right now if you count all late notes. Just over 3% of my notes have defaulted and been charged off. I imagine that number will continue to go up as I invest in more notes.
Prosper.com makes it very easy to see how much money and % interest you are earning on your account. You can link your bank account and setup up automatic payments to Prosper.com every month as well and have that money get invested immediately.
If you ever need to withdraw, just turn off automated investing for a time, collect some interest, make a transfer to your bank account, then turn that automated investing back on. To do that, just uncheck your automated investments on the automated quick invest page.
P2P Lending Monthly Statements
Prosper.com will also send you a monthly statement showing you how much interest you earned that month. This is extremely helpful to gauge your passive income per month potential.
My last statement was for December 2020, and the interest was nearly $400. This amount will vary depending on how many notes default that month. But I'm pretty happy with nearly $400 for only an hour of work or less for that month!
The reason for the high cash balance is I dumped an extra $3,000 into Prosper.com for that month and it hadn't been automated to new loans yet.
Downsides To P2P Lending
You'll have a tax form to use when you file your taxes each year, so it's some extra work on your taxes. In addition to that, like anything, you could have a ton of people default on their loans and lose money. You can mitigate this by diversifying your loans. These are the only downsides I see. I'm earning over 10% and love it so far.
P2P Lending Conclusion
It has been over two years now and Prosper.com has outperformed all my other investment attempts. I'm sure I could do even better with my investing at Prosper.com, however, I'm happy with a 10% return or more that only takes me about an hour per month to manage.
Right now, it's like I'm earning about $300-400 a month interest per hour (for 1 hour) and that amount will continue to rise for that hour of work. It's like I'm raising my hourly rate; that's the way I look at it.
If you can take a few hours and sign-up for an online account, get some money transferred, and invest in over 100 loans in a diversified way, you have a good chance to make returns.
Update 2022 On Passive Income Investments
My favorite type of passive income investment for 2022 and beyond is real estate crowdfunding. It's nice to have a tangible asset that generates income.
The value of real estate and rental income have gone way up because interest rates have come way down. It takes a lot more capital to generate the same amount of risk-adjusted income. Further, we're all spending a lot more time at home due to the pandemic.
As inflation expectations pick up, you want to own real estate. Inflation whittles down the real cost of a mortgage and boosts the value of your property. Her is my latest passive income streams. Currently, I don't have any P2P lending passive income due to my interest in real estate.
My favorite two real estate crowdfunding platforms are:
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. Investing in a diversified eREIT is the easiest way to gain exposure for most people.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields. They also have potentially higher growth due to job growth and demographic trends. If you like investing in individual deals, CrowdStreet is an excellent platform.
I've personally invested $954,000 in real estate crowdfunding since 2016 to diversify my investments. It's nice to earn income 100% passively as I spend more time taking care of my children.
Both platforms are free to sign up and explore.
Invest In Private Growth Companies
Finally, consider diversifying into private growth companies through an open venture capital fund. Companies are staying private for longer, as a result, more gains are accruing to private company investors. Finding the next Google or Apple before going public can be a life-changing investment.
Check out the Innovation Fund, which invests in the following five sectors:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI!
The investment minimum is also only $10. Most venture capital funds have a $250,000+ minimum.Investing in private growth companies could have much stronger returns than P2P lending.