Micro loans. A good idea?

[Balog]

My wife has broached the idea of making micro loans through something like prosper.com as a means of getting started in investing. I'd heard the concept discussed a while back on the radio, but never really looked into it.

At a surface glance it does seem to offer some advantages. Higher rate of return over a shorter span, more control, less initial investment required. But I can see a number of glaring issues looming as well; collecting on bad debts, people lying through during the screening process, much higher due diligence required on our parts etc.

So what say you APS? Anyone have any knowledge/experience with this kinda thing?

[Manedwolf]

If you're spending money you don't have to invest, you're already starting out negative and have to hope that interest charges don't exceed your dividends...which is more than likely!

Remember, if this worked out so well, those loan companies wouldn't be making loans to people...they'd be investing in your wanted investments instead. Gathering interest charges is more lucrative, which means they're going to make out better.

Don't invest money you don't have, IMO. Put money aside, do some on the side jobs, whatever, and invest that instead.

Also: http://www.finance-weblog.com/50226711/why_prospercom_will_fail.php

[Balog]

I really have no idea what you're talking about. I'm not saying that to be facetious, I'm literally confused. "Money I don't have" what does that even mean?

Here's my understanding of the general stock market. Let's say I have $500 to invest. I've maxed my 401K, I'm out of debt, and I"ve got a bit extra I want to earn more interest on without putting it out of reach for years and years. I buy stock A at $100 a pop, so 5 shares. Company A does great, and in 6 months the stock is up to $105. Net profit to me, $25 not counting fees etc.

Alternatively, I could loan that $500 to someone at %15. Assuming thorough due diligence I doubt it'd be that much more risky than a traditional stock, especially given the volatile nature of the market. Six months later I have $75 to show for it.

Am I being stupid or not understanding something here? I freely admit I don't know much/anything about investing. I'm here to learn, so feel free to point out where I'm off track.

Oh, and the same guy who wrote the article you linked to also wrote http://www.finance-weblog.com/50226711/counterpoint_why_prospercom_will_succeed.php

[BrokenPaw]

Maned,

I think that Balog was looking at being a lender on that site as a way of investing, not borrowing from that site in order to have money with which to invest.

But the point made in the article you linked to still stands.

-BP

[Manedwolf]

Maned,

I think that Balog was looking at being a lender on that site as a way of investing, not borrowing from that site in order to have money with which to invest.

But the point made in the article you linked to still stands.

-BP

Ack. That, I think, would be an even worse idea.

How are you supposed to know if the single mother with a sob story is really a bunch of hackers somewhere in the Ukraine? Talk about getting burned...

[Balog]

True, and that is my biggest concern. However, they claim to have a ton of safeguards against that sort of thing. I suppose I was asking if anyone knew how effective those safeguards are. Looking back at the OP I can see how it could be misconstrued. I'll edit it for clarity.

[Manedwolf]

Yeah. I thought you meant you were looking to borrow funds to invest with in hopes of making more than the interest rate.

As for lending...I'd just be concerned. Safeguards are only as good as whoever is keeping one step ahead of identity-stealing hackers. I'd be realllll cautious, there. As in limiting to the local area with face to face or at least telephone meetings with the borrower or such, to be sure they're really who they say they are.

I'd worry that the "safeguards" wouldn't help if someone who was a good risk had their identity stolen, and the person applying for the loan was the ID thief!

[BrokenPaw]

True, and that is my biggest concern. However, they claim to have a ton of safeguards against that sort of thing. I suppose I was asking if anyone knew how effective those safeguards are. Looking back at the OP I can see how it could be misconstrued. I'll edit it for clarity.

If you want to play with this, I suggest a Vegas strategy:  Bet only with money you can stand to lose.  In fact, write off your stake money (in your mind) as a loss before you even begin.  Go to the casino with your stake in your right pocket.  Put any and all winnings in your left pocket, and never bet with any money from there.  Once your right pocket is empty, quit.

-BP

[Azrael256]

Don't lend money.  Bad Idea(tm).

Buy index funds or something stable.  TANSTAAFL.

[Manedwolf]

With this sort of thing, I wonder if there would be any liability if money was lent to someone, and then it was misused for a criminal purpose? (As in, "We just arrested this person making a drug buy. Where did they get the cash?" "Someone named X seems to have lent it to them over the web. Should we investigate any possible connection?") Or is there some sort of protection for lenders, and does it apply to "private" lenders, or only government-certified ones?

I'd want to find that out. I don't know.

[Balog]

Maned,

I think that Balog was looking at being a lender on that site as a way of investing, not borrowing from that site in order to have money with which to invest.

But the point made in the article you linked to still stands.

-BP

Ack. That, I think, would be an even worse idea.

How are you supposed to know if the single mother with a sob story GM is really a bunch of hackers somewhere in the Ukraine about to go belly up? Talk about getting burned...

Any investment is a risk. From my admittedly limited knowledge it would seem traditional stocks are not a good place to invest small amounts of money, or for a limited time. I'm trying to figure out the actual risk based on the past performance of the loans, not speculation about all the ways it could be go wrong from people who're unfamiliar with the actual process.

[Balog]

Don't lend money.  Bad Idea(tm).

Buy index funds or something stable.  TANSTAAFL.

But the return on investment is generally so low as to be pointless, in my understanding. An extra one or two % yield over a savings account may be worthwhile for a large amount, but when it's a few hundred it hardly seems worth it. Put your money where you can't access it for a couple years, and after all the fees are taken out end up with $20 more than if you'd just kept it in the bank? No thanks.

[Brad Johnson]

The whole thing reeks of a get-rich-quick scheme.  The only people guaranteed to make money are the prosper.com middle men.  You are the capital, they are the managers.  The only person taking a risk is you.  They loan your money to someone and charge 20-30% interest.  In return they pay you 15% (more than likely only after the loan is repaid in full).  If the borrower defaults they aren't out a thing but you lose it all.

I'm trying to figure out the actual risk based on the past performance of the loans,

People that will borrow short-term money in that interest rate category are probably high-risk borrowers.  My guess is the default rate will be somewhere in the 20-25% range, minimum.

Nope, not for me.  I say put it in medium growth mutual funds and let it ride.

But the return on investment is generally so low as to be pointless,

Therein lies a very large problem.  You have have a millionaire's expectations and are trying to fund it with a blue-collar pocketbook.  And you want it NOW!  Ain't. Gonna. Happen.  You're looking for immediate gratification of the financial sort without the means to underwrite it.  You don't have the capital for a large short-term return on speculative items.  Period.  So forget about it.

For you to make a quick short-term return with $500 you'll have to use it as a springboard for something else.  Example - use the $500 to get a auto dealers license and buy $1500 auction beaters that you could turn in a week for $2000-2500.  Sticking that $500 somewhere then sitting back and expecting people to fall all over themselves paying you money is unrealistic.  Unless you have access to a bunch of capital, either your own or from investors, you can't afford to think short-term.  That is, unless you intend to go into loan-sharking or something equally shady.

Investing is long-term, not something you do in 6-month chunks.  The savviest investors, the ones who make the most overall, do one of two things.  If they have money to burn they bet a big chunk on a few high-risk investments.  If they are like you and me they put their ongoing small contributions into proven performers and forget about it for a couple of decades.  Regular contributions and compound interest are your friends.

Brad

[Manedwolf]

For short-term investing with a few thousand, I've seen some people use metals stocks like the Street Tracks gold fund like a slowly bouncing ball, buying and selling during the recent variances of about $200 per ounce. Trading is instant, and only incurs the usual low online brokerage fee, which for most is something like $7. Yeah, it can stagnate, too, but any investment is risk. You can even set the high and low points to make it automatic if you want.

Then, for every few hundred you get from the bounce, you can push that into something with a long term yield instead.

[Brad Johnson]

For short-term investing with a few thousand, I've seen some people use metals stocks like the Street Tracks gold fund like a slowly bouncing ball, buying and selling during the recent variances of about $200 per ounce. Trading is instant, and only incurs the usual low online brokerage fee, which for most is something like $7. Yeah, it can stagnate, too, but any investment is risk. You can even set the high and low points to make it automatic if you want.

Then, for every few hundred you get from the bounce, you can push that into something with a long term yield instead.

A lot of people go broke trying that.  Far more than actually make it.  Playing the markets is something you need a lot of time and resources to do properly (and intelligently).  Unless you have the money to lose, and the time to devote to research and monitoring, there are far less risky ways to make your money grow.

Brad

[Manedwolf]

For short-term investing with a few thousand, I've seen some people use metals stocks like the Street Tracks gold fund like a slowly bouncing ball, buying and selling during the recent variances of about $200 per ounce. Trading is instant, and only incurs the usual low online brokerage fee, which for most is something like $7. Yeah, it can stagnate, too, but any investment is risk. You can even set the high and low points to make it automatic if you want.

Then, for every few hundred you get from the bounce, you can push that into something with a long term yield instead.

A lot of people go broke trying that.  Far more than actually make it.  Playing the markets is something you need a lot of time and resources to do properly (and intelligently).  Unless you have the money to lose, and the time to devote to research and monitoring, there are far less risky ways to make your money grow.

Brad

Well, I'd meant if you just had a few thousand to play with. That one I mentioned, GLD, has a 52-week low of around 66 and high of around 100 or so. If you had put in $2000 at 66 and took it out at 100, and kept the money you made to put in something else, that's not bad. But no, you shouldn't keep putting money in something like that. Yes, it could get stuck somewhere for years. No, you would not want to get into that now, it's at a high, you only do those during corrections.

And it should only be money you can afford to lose. The hardcore traders, as to time...the joke is that they don't even dare run to the bathroom when things are moving quickly.

[Balog]

Ok, so goes anyone know how I can get the actual figures on defaults? Not speculation, not "I reckon it'd be about this much" but actual documented statistics?

I'm not trying to be argumentative here, it's just frustrating to have a bunch of opinions expressed with no way of verifying them.

So let me see if I have this straight. Unless I have tens of thousands of dollars and tons of experience, there is no way to invest that'll pay off in a meaningful way inside of a decade? Am I understanding this correctly? I'm not disagreeing, I'm merely trying to understand.

[Manedwolf]

So let me see if I have this straight. Unless I have tens of thousands of dollars and tons of experience, there is no way to invest that'll pay off in a meaningful way inside of a decade? Am I understanding this correctly? I'm not disagreeing, I'm merely trying to understand.

You can start a good investment with a little money, but it will take time to grow.

Consider it a seed. In time, it can become a huge tree, but it will take time. You can't drop it in the ground and expect a fully formed tree to explode up, that's just not how it works...or everyone would be rich.

There's two ways...long-term safe investment that takes a long time to grow, or high risk shorter term investments.

The drawback of the latter is the risk. You can win...or you can lose. It's a gamble.

[Brad Johnson]

Ok, so goes anyone know how I can get the actual figures on defaults? Not speculation, not "I reckon it'd be about this much" but actual documented statistics?

I'm not trying to be argumentative here, it's just frustrating to have a bunch of opinions expressed with no way of verifying them.

So let me see if I have this straight. Unless I have tens of thousands of dollars and tons of experience, there is no way to invest that'll pay off in a meaningful way inside of a decade? Am I understanding this correctly? I'm not disagreeing, I'm merely trying to understand.

The company should have a record of default rates.  It's a required disclosure.  It should be somewhere on the web site, probably under Terms and Conditions or something similar.

Don't be surprised if they make it extremely difficult to fine, or if they balk at giving it to you when you call.  I'd bet a good hamburger that the default rate is scary-high.

Consider this... if the loans are such a good deal, why aren't they making them with their money instead of getting you to take all the risk?

Brad

[Balog]

Yeah, I understand the concept of long term investments. I love them. And I know there is no free lunch; I'm willing to put in the arduous legwork necessary to mitigate the risks. I'm not looking for easy money; I am looking for decent return on investment in the short term.

Maybe that is a pipe dream, I dunno.

[Brad Johnson]

I am looking for decent return on investment in the short term.

Step Number One ... Stop thinking in dollars and start thinking in percent.

Brad

[Manedwolf]

I've actually had good luck with mutual funds. CGM had a 26% return last year for me!

[Azrael256]

So let me see if I have this straight. Unless I have tens of thousands of dollars and tons of experience, there is no way to invest that'll pay off in a meaningful way inside of a decade? Am I understanding this correctly? I'm not disagreeing, I'm merely trying to understand.

Pretty much, yeah.

Trying to beat an average of about 10% per year is pretty much straight-up speculation.  That average comes from about fifty years of statistics, so you could have a good decade, or a bad decade, but the last fifty years have averaged about 10% each year of market growth.  So, at that rate, your money will more than double in a decade (assuming an average decade).  

So, if you start with 5k, and add 1k each year, in an average decade you will end up with more than 30k.  That's twice your total principle.  If you start with the 15k principle, you'll have almost 39k at the end of the decade with no addition to principle.

The only other options are starting a highly profitable business, or win the lottery.  Or marry rich, I guess.


Edited to add:

Looking at Prosper.com's site and rates... pff.  Their rates are unimpressive. 

As a further vote against it, Benjamin Graham mentioned CMOs once in one of his books.  I believe his exact words were "if someone approaches you trying to sell CMOs, tell him you're late for an appointment with your proctologist and walk away."  Looking at their default statistics, I'd dump my life savings in a CMO before I'd buy there.

[Balog]

Yeah, I'm not really sold on the idea. Here's what I was thinking, in general terms.

I want to have a solid chunk in the bank as emergency money in case of sudden car trouble or medical issues. But Savings accounts have crap return rates, and traditional investments take decades. So if i could put my emergency money into a short term investment with a decent return, it'd be kinda the best of both worlds. Dunno if that's possible, but it's what I was thinking.

[Azrael256]

Ok, what's your idea of decent?

Money market funds are highly secure, turn a little better than prime, and can be liquidated in 24 hours.
CDs can be purchased in many amounts, usually $1000 or more, and I see a few paying 3% APY for 30-day terms.
Bond funds (which aren't terribly different from money market funds) are highly regular and pay decent rates.  Some mixed funds (look for "income" funds) turn maybe 5% and contain some equities that also offer capital appreciation.

If you don't have a lot of emergency expenses, a short-term bond fund will probably provide sufficient liquidity, and will pay a bit more than a money market.