What a difference a year makes. Early last year, I reported on my experiences with three fintech investing platforms in My Adventures in Fintech. I gave readers a glimpse into my actual portfolios and the yields they generated. In this article, I again throw open the covers of my accounts with the fintech platforms Lending Club, Upstart and Acorns. In addition, I review my more recent experience with Fundrise, a low-cost platform for non-accredited investors to invest, on a fractional basis, in real estate.
The key takeaway is that yields across these platforms over the last year-plus have significantly decreased. With Lending Club, for example, my relatively new portfolio generated a net annualized return of 9.5 percent in 2017. Eighteen months later, the yield is down to 5.10 percent.
How to account for such a decrease? Some of it’s entirely predictable and I predicted some of it. Loan defaults tend to be concentrated in the 18 to 24 months after loan origination and my portfolio reflected that dynamic. Default rates among the highest risk notes exceeded expectations. Moreover, investor demand for these notes—especially large injections of institutional money—has outstripped borrower supply, lowering yields.
There have been other changes. Let’s take a deeper dive into each in turn.
Lending Club creates a marketplace between individuals who need unsecured loans and investors who are willing to fund those notes. In early 2017, I had fractional interests in 3,167 notes, mostly 36-month loans. Each note represents a borrower who has promised to repay the loan at a fixed interest rate. Each investor in the note receives a proportional slice of the principal and interest payments as they’re received. These notes are unsecured and a certain number of defaults are inevitable. In fact, 12 percent of my notes last year were charged off at various points before the loans matured. A few notes were a total loss as the borrowers failed to make a single payment, but most notes defaulted in the 18 to 24 month time frame, so I did receive some repayments.
My most recent statement shows that I own fractional shares of 6,234 notes (figure 1). I made the decision last year to rebalance my portfolio in favor of less risky and lower interest notes. My portfolio is weighted heavily in the most conservative A, B and C notes. In fact, A, B and C notes represent 75 percent of my portfolio (figure 2). This shift in my portfolio likely kept my returns from going even lower.
Hundreds of notes in my portfolio are maturing every month. Of my 6,234 notes, a total of 622 notes have been charged off, representing a default rate of 9.9 percent. Even accounting for the defaults, the overall net annualized return I received in the last 12 months was 5.10 percent.
As recently as 2017, Lending Club investors could pick and choose among borrowers based on a number of demographic dimensions. While the identity of borrowers was always hidden, investors could select notes by such variables as credit scores, state of residence, owners or renters, years on the job, and other filters. Some investors claim to have a secret sauce for selecting the best performing notes, but I continue to doubt such claims and the amount of time needed to build a portfolio one note at a time makes such a proposition impossible to me. In any case, Lending Club has eliminated such granularity. Today, investors must allow the Lending Club algorithm to select notes for their portfolio. Investors can fine-tune the algorithm to select the mix of risk/reward they’re comfortable with. Lending Club charges borrowers origination fees and charges investors account fees.
Lending Club is unique among peer-to-peer platforms in that it offers investors a secondary market for selling notes before they mature. Folio offers a robust auction marketplace where investors can sell performing notes or even offload late notes at a discount to buyers willing to take higher risks. Rarely, notes in default are cured; there is a deeply discounted market for such notes. For investors who luck out, some of these notes have effective yields of upwards of 200 percent. I tested the Folio platform and found that I could easily liquidate hundreds of Lending Club notes, both current and late, on agreeable terms.
Upstart is a peer-to-peer lending marketplace for accredited investors. Founded in 2012 by three ex-Google engineers, Upstart provides loans to borrowers who are thought to be good credit bets but may not be conventionally creditworthy. These borrowers are often recent college graduates with high income potential but may not have much in the way of credit history (as they are at the beginning of their careers). Upstart’s machine learning algorithm looks beyond traditional credit data to factors such as college degree, test scores, employability, and earning potential.
Like Lending Club, Upstart has eliminated the ability to cherry-pick notes. It was vaguely virtuous to search among the notes to find the most promising young professionals to invest in. Today, investors determine the mix of notes by term (36-month or 60-month) and risk grade. Upstart selects notes as they become available.
When I first reported on Upstart, I had only 140 36-month notes exclusively from Grade B borrowers. With one default at the time, my net annualized IRR was 7.24 percent. Today, my portfolio has 578 notes, of which 488 are current, 69 have matured, 9 are delinquent and 12 have been charged off (figure 3). The default rate is 2 percent, compared to 10 percent for Lending Club, an indication that Upstart’s proprietary lending algorithm may be on to something. My yield, year-to-year, fell by more than a percentage point to 6.05 percent, which is slightly lower than the average investor return of 6.3 percent.
Based on Upstart’s performance statistics (figure 3), my performance of 7.42 percent is apparently better than the 5.72 percent average across all notes (figure 3).
Acorns is more of a savings platform than a robust retirement device. Acorns is the digital equivalent of emptying your pocket of coins into a jar at the end of the day and watching the change mount up. When you link your credit cards and checking account, Acorns simply rounds up each of my purchases to the next dollar and invests the difference in a diversified portfolio of low-cost ETFs. For example, when I charge, say, a book for $30.10, Acorns sweeps the 90 cents difference into my account. The roundups come from my checking account. When the roundups total $5, the Acorns algorithm goes into action and, based on my settings, invests in one of six ETFs that range from conservative to aggressive.
Now that I have two years of experience with Acorns, I can report my balance is now $4,986 including dividends of $70 and a total gain of $282. This represents a return of 5.05 percent. Fees are $1 per month or 0.25 percent per year, depending on my balance.
Real estate should be a part of every diversified investment portfolio. For most investors that means betting the equity in their primary residence, which the 2008 financial crisis reminds us is not always a good bet. Investing in a real estate investment trust is one way to go, but fees can be high and liquidity a problem. Enter into one of the most successful crowdfunded real estate platforms. Founded in 2012, Fundrise provides access to an asset class not typically available to the average investor. Fundrise lets unaccredited investors participate in commercial real estate by spreading investments of as little as $500 across dozens of properties using their low-cost Growth eREIT.
One thing I like about Fundrise is how lean the operation is. The company uses funds raised from investors like me to buy ownership positions in residential and commercial real estate around the country. One power of investing with a crowd is that, because Fundrise assumes a senior position, in the event of a failed project, it gets paid ahead of other lenders/owners.
Fundrise currently offers a number of eREIT funds to choose from to diversify risk and optimize either income or appreciation. The Fundrise algorithm then allocates investor funds to buy fractional interests in properties with the optimum blend of dividend growth and appreciation (figure 6).
It’s too early for me to calculate a meaningful return on investment, but according to Fundrise, the most recent average annualized returns were 11.44 percent in 2017; 8.76 percent in 2016; 12.42 percent in 2015, and 12.25 percent in 2014 (figure 7).
Unlike publicly traded REITs which may be bought and sold, Fundrise liquidity is limited. Since all the crowdfunded assets are quickly invested in properties, investments cannot be immediately withdrawn. Fundrise provides windows four times per year during which investors can cash out without penalty. Fees are typically 1.00 percent per year.
Peer-to-peer financial technology platforms, or fintechs, and startups like Acorns will continue to diversify, innovate, and democratize investing. These platforms are filling a much-needed role in the financial services environment and, as millennials and GenXers think about investing for retirement, they will increasingly look to platforms such as these as custodians of their retirement funds.
With the decrease in yields, do these platforms still make sense as part of a diversified investment portfolio? That’s the big question. On the whole, I think they do. While yields are lower, so are expenses and fees. For the risk represented, these investments still provide a good upside as well as diversification.