The Large Impact of Early Defaults on ROI

I have been keeping a daily track of my NAR on all my Lending Club accounts now for almost a year. I have also been doing this for my Prosper accounts since they introduced annualized return numbers back in October. During this time I have been able to observe the negative impact that defaults have on the annualized return calculations.

My Roth IRA account at Lending Club was opened in April 2011 and was fully invested by October. So, this account has an average note age of around six months with the oldest notes being almost nine months old. This account is invested in high interest/high risk notes: D-G grades. So I expected many defaults and so far I have had three. It has been interesting to see what these defaults have done to my NAR calculation.

Here is a screenshot of this account from three months ago when there were no defaults followed by one from this morning showing the impact of three defaults on my NAR.

October 2011 Lending Club Roth IRA

January 2012 Lending Club Roth IRA

Three defaults have dropped my NAR roughly 4%. In fact, it is a little worse than that. My NAR the day before my first default was 18.53% and last week after receiving my third default it was at 14.48%.

My First Lending Club Default Dropped My NAR 2.26%

The first default back in October saw my NAR go from 18.53% down to 16.27% in one day. Now, I expected this but for a new investor a drop like that may come as somewhat of a shock. But when you think about it, this makes sense. The total principal loss of say $24 impacts your returns far more when you have only made $180 of gains.

For comparison, last week my wife’s Lending Club IRA (that I recently took off PRIME) received another default (the 35th default in this account) and the NAR went down exactly 0.09%. This is because the account is over 18 months old and it has had around $10,000 in interest received, so a principal loss of $45 has very little impact on the overall return.

The Lesson: Don’t Freak Out About Defaults

I hear from many new investors who are utterly dismayed when they receive their first default. They go back over the loan listing and wonder where they went wrong. But when you are investing in p2p lending, even if you stick with just A-grade notes, defaults are going to happen. And in the early days of your p2p investing they will have an oversize impact on your ROI.

While defaults are never welcome, I have learned to accept them. As long as my overall returns remain strong I barely give them a second thought.

For an interesting look at projecting ROI check out this post from Nickel Steamroller yesterday.

  • Peter Renton is the chairman and co-founder of LendIt Fintech, the world’s first and largest digital media and events company focused on fintech. Peter has been writing about fintech since 2010 and he is the author and creator of the Fintech One-on-One Podcast, the first and longest-running fintech interview series. Peter has been interviewed by the Wall Street Journal, Bloomberg, The New York Times, CNBC, CNN, Fortune, NPR, Fox Business News, the Financial Times, and dozens of other publications.