Is Lending Money on Prosper.com Competitive With Other Investments?

November 8, 2007 By Matthew Paulson

When most of us loan money to our friends, we give them $20 or $30, and they pay us back a week or two later and we think nothing of it. If the person was willing to pay a little bit in interest, you could make a little bit of money off the deal. Now what if you took the money in your savings account repeated this process this process hundreds of times to different friends around the world? This is exactly what Prosper.com is allowing people with money to do, and many people are making it part of their investment portfolios. The question arises, how does lending money through Prosper.com compare to other investments such as mutual funds, real estate, and simple savings. Let’s find out.

We know that one of the most important factors in an investment is risk. You could go down to Las Vegas, play roulette at one of its many casinos, and put your entire life savings on black. It would provide a 100% rate of return on your investment if you won, but nobody does that because it involves far too much risk. When you factor in risk, it’s just not worth it. The same is true for other investments. You might have the option to invest in some hot new tech company that could potentially double or triple your money, but you might not do it because it’s a very risky venture.

Prosper.com recently launched “portfolio plans” which automatically fund loans for you and will give you a better idea of what kind of money you might make after adjusting for non-payment by borrowers and service fees. With their balanced plan, you’ll make about 13.5% interest on the money you invest. When you adjust for risk and the servicing costs, that number ends up being 9.14%.

The rate of return you’ll get through Prosper is very comparable to what you might find when investing in a mutual fund. There are hundreds of mutual funds which will earn you anywhere from 9% to 13% year over year over a long period of time. Does this mean the investments are equal? Not exactly, you still have to consider the tax consequences of both options. If you invested $1000 in a mutual fund and earned 10% on it in one year, you would have to pay a capital gains tax of 15% of the amount of money that you gained, so you would pay 15% of $100 which ends up being $15.00. If you loaned $1,000 on prosper and earned 10% on it in on year, you would have to pay your full tax rate plus the self employment tax. Depending on you tax rate, you could be paying upwards of 30-35% when all is said and done. So instead of sending $15.00 to the government, you’re sending over twice that!

Currently Prosper.com has no options which allow you to invest money into loans through any sort of tax-beneficial retirement account, so you’re stuck paying your ordinary income tax rate on any money that you earn. It might look the same when it comes to interest rates, but when considering the investments holistically, there’s just no comparison.

Prosper.com might not be able to beat out a typical mutual fund in terms of investment, but it is several steps ahead of a savings account at an online bank such as ING Direct or HSBC Direct. You’ll only earn around 4.5% APY on your money at these places, but you know that your money is guaranteed. If you invest in conservative loans on Propser.com, you can still almost get twice that after factoring in fees and lost funds due to non-payment and have a relatively secure investment.

The only problem with that is that the money you put in Prosper.com is not liquid. You won’t get your full amount back plus the interest until the loan is paid off 3 years down the road. Prosper.com appears to be planning a means for lenders to sell their loans to other lenders based on a recent FCC filing, but that’s a bit down the road yet.

Prosper.com certainly won’t replace stocks, real estate and mutual funds that you are using to save for retirement, but it will provide a bit better rate of return than a traditional savings account.

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