I think that most regular readers of the blog know how much I enjoy earning a huge interest rate through the peer-to-peer lending website, Lending Club. For those of you who are not familiar with Lending Club, they are away to cut out the middleman and earn a great rate of return on your investment. Instead of having to go through the traditional route of borrowing money from a bank or lending money to a bank in the form of deposits, people can log on to a peer to peer lending networks such as Lending Club and lend money directly to other people who are also members of the website.
15% Rate of Return. I earn less than 1% on my money market funds. I earn a little over that through online savings accounts such as an ING Direct Orange Savings Account. But, I have consistently earned slightly over 15% per year on the money that I invest through Lending Club. I’m earning 15.6% on 48 different loans. Check out the criteria I use when selecting which borrowers I invest in.
Compound Interest. But, there is a way to ramp up your investing in Lending Club that will take your earnings to the next level. It is compounding interest. When you invest in a loan through the site, you will earn a monthly income from that loan as the borrower repays the loan every month with principle and interest. So, what is the best thing to do with that income? Invest in more loans from borrowers of course. That way your interest will be earning interest just like compound interest from a savings account. Even Albert Einstein called compound interest the 8th wonder of the world.
So, for example, if I were to loan an individual $100 (a small portion of their total loan request), I would earn approximately $15 each year assuming a 15% rate of return. By the end of the third year, I would have earned $45 in interest and my principle back. I can then participate in a loan with that $100 and the $45 too. 15% on $45 is $6.75 per year or $20.25 over three years. Now, my interest can continue to purchase portions of loans protecting the original capital that I invested. In fact, with as little as $2,500 in principle, your investments can earn over $25 per month in payments which could then be used to fund new loans. This is an easy way to earn a passive income without having to put any more of your own money towards the investment. It is an easy and great way to grow your investment portfolio and diversify your holdings with limited risk.
By The Numbers. Thanks to the power of compounding interest, you could see your balance double every five years if you were able to continue with a 15% annual rate of return on your investments. After twenty years of investing $25 per month at 15% annual rate of return, you can expect to have over $37,400 in your account after investing only $6,000 of your own money. Very nice!
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I have been reinvesting my earnings from Lending Club as well and I was pleased to see my interest rate go up as well. I plan on getting to the point where I earn enough in interest to fund a new loan every month so that I will not have to take money from other areas to invest.
While I too encourage reinvesting all received payments to maximize one’s return, I believe you may be misunderstanding the numerical effect of an interest rate on one’s total return.
For the sake of argument let’s say that you invested $100 in a single 3 year LendingClub loan at an interest rate of 15%. Your total return on the loan without reinvestment (and ignoring defaults or fees) over the 3 years will be $24.80, far less than the $45.00 that you state in your piece.
The reason for this apparent “discrepancy” is quite simple – the borrower is returning a portion of the original principal with every payment. In fact the proportion of each payment that represents returned principal grows with every passing month, to the point whereby towards the end of the loan the payment is composed of nearly all returned principal.
To put it another way every dollar of returned principal stops earning interest as soon as it is returned to you.
So the impact of reinvesting all returned principal is not to “supercharge” the returns past 15%, but to get you from 8.3% to 15% with respect to the original principal amount. (And so long as you can continue to reinvest all returned principal, this effectively keeps constant the percentage of each month’s payment which comprises interest, which of course will be 15%.)
Where we do agree, though again we differ wildly on its numerical impact, is the >15% returns one can get by reinvesting any paid-up interest. (Though technically you’re still getting a 15% return, just on a larger principal amount.)
I prefer to reinvest principal only and withdraw interest monthly for extra income.
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