Beating Broke

Personal Finance from the Broke Perspective

Calculating a Real Rate of Return on My Lending Club Portfolio

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For the past month or so, I’ve been performing a bit of an experiment.  I’ve been taking 10% of all income from this and my other sites and splitting it between an investment account and my Lending Club portfolio.  The idea, of course, is to see which performs better.

In order to do that, I needed to find a good way to calculate what the real rate of return to me is.  Here’s the formula I settled on.

(1- (Total Deposits / ((Total Deposits + (Total Interest Received – Fees Paid))*.97)))

I should qualify the rest of this by saying that I’m not the best at math, so there may be flaws here.  Feel free to let me know in the comments.  Also, if there’s a better way to go about this, please let me know in the comments as well.

Golden Guy Balancing RiskSo, let’s break that down a bit.  The *.97 part is  meant to give some accounting for inflation.  It takes 3% right off the top as an inflationary cost.  Is 3% enough?  That’s debatable, but it seems like a fair average, historically.  This bit: (Total Interest Received – Fees Paid) is merely the total income on the portfolio.  I’m missing a small bit here, as the cost of the principle is not equal to the actual principle of the portfolio.  That’s because I live in a state where Lending Club doesn’t have the right permissions to allow me to directly invest in the loans.  So, I’m having to go through their foliofn note trading platform to buy my notes and there is usually a small premium on the notes.  I haven’t decided on a good way to really include that in, or if it really should be.  The next bit, (Total Deposits / ((Total Deposits + that previous bit is basically determining the % growth.  Total deposits divided by current “balance”.  The 1- part at the beginning just gives the cleaned up decimal percentage.

Let’s walk some numbers through it. We’ll use these:

Total Deposits = $1000

Total Interest Received = $25

Fees Paid = $5

So, plugging those numbers in we get: (1-(1000/((1000+(25-5))*.97)))

We’ll do this old school and solve as we go, showing our work.  Parenthesis get priority, followed by addition and subtraction.  So, we next end up with (1-(1000/(1020*.97))).  Then, we end up with (1-(1000/989.4)).  Next step, 1-1.011 = -.011.  So, we get a return of -1.1%.

Seems logical right?  In the case of my portfolio, the result comes back as 10%.  That’s a pretty good number, if you ask me.  I haven’t had any defaults yet, and I’ve had loans in my portfolio since January of 2010.  (the experiment I talked about earlier only began in July, however, but previous portfolio is included for easy of calculations)

I’m sure there’s some much more complicated formula that would take in risk of default on remaining invested principle, and a way to get the most accurate number, but really, I’m not sure that I want to take it that far.  This will never get to the point, I don’t think, of having a majority of my overall portfolio in it.  It’s not nearly safe enough for that, and my retirement accounts will remain in more traditional markets.

But, with results like 10%, and the current state of the stock market, one has to begin to wonder if the stock market is the safer of the two markets.  The stock market certainly isn’t showing returns of 10% recently.

photo credit: lumaxart

Has Stock Trading Ruined the World?

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The very basic essence of stocks is that you buy a “share” of a company in order to own a portion of the company and “share” in it’s successes.  If the company decides to not reinvest it’s profit into itself and instead pay a portion, or all, of that profit to the owners, you get a bit of it in the form of a dividend.  It the company does reinvest the profits into itself, it increases the value of the company, and your “share” of the company increases in value as well.  You can then sell your “share” of the company to realize that increase.

But, that’s only at it’s most basic level.  Today, the world of stock investing is so much more.  There are options, short selling, margin trading, ETFs, mutual funds, hedge funds, and a myriad other ways that you can partake in this sometimes exciting, and always risky world.  It isn’t just simply owning a portion of a company anymore.  You can sell shares of companies that you never owned in the first place.  You can buy on margin with money you never had.  And you can do it all whenever you want.

Bear MarketBut, has this evolution of the stock market become a cancer on the world?  So much of our economy relies on the stock market as an indicator of the world economic health.  If stocks drop, so too does much of the rest of the economy.  And if a company does poorly, and many of it’s shareholders sell, causing the price to drop, it can have a ripple effect on the rest of the industries companies, or even on the stock market as a whole.  In May of 2010, just such a sell off caused a drop in the stock market that had the entire world trembling in fear of a worldwide economic collapse.  It was caused by a trigger in an computer algorithm that was mistakenly set wrong.  Many of the stock markets closed early to try (unscheduled rather than one of the normal stock market holidays) and curb the crash and hold off a more drastic drop.

The way the stock market works has evolved so much in order to optimize the buying and selling of shares of companies merely for the profit of the brokers and day-traders.  Very few investors will buy a share with the intention of holding it for more than 5 or 10 years.  That’s a drop in the bucket for companies that have been around for over 100 years.

Events like the crash of May 2010 and the crash in 2008/2009 due to the real estate bubble bursting give us all pause when we think about investing.  For those of us who don’t want to try and “beat” the market and who proscribe to a more long term approach to investing, the drastic ups and downs of the market are cause for concern.  What happens if the crash can’t be stopped?

Is it fixable?

Perhaps, but I don’t think that the many brokers and traders who make their money with the newer methods of investing will allow it to happen.  To truly fix the market, it needs to revert to it’s much more simple state.  Simple buying and selling of shares.  No options, no shorting, no margin.  Just ownership of a company.  After all, that’s what it’s really about.  And if it can’t be fixed (or won’t be allowed to be fixed), perhaps it’s time the investors who don’t like the way it’s working move our money someplace else.  There are plenty of opportunities in your local communities to invest in start up companies and other investment vehicles.

A word of warning though.  Those local opportunities are generally much more risky than buying a share or two of a company like Proctor and Gamble who have been around for decades.  Only about 10% of start-ups still exist 5 years later.

Risky as it is, the stock market can still be a sound place to keep your money.  Yes, you do run the risk of losing your investment.  Nothing there is insured or guaranteed like you would see if you had your money in a savings account at a NCUA insured Credit Union or a FDIC insured Bank.

Has stock trading ruined the world?  Not yet.  Will it?  Let’s hope not.

Image Credit: Bear Market by AZRainman, on Flickr

The Debt Free Treadmill

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Treadmill WorkoutWhen you’ve got bills and debt to pay off, you are constantly feeling like you’re running a personal finance marathon.  Each month is a sprint to the finish to see how much debt you can pay off.  We do it to get to that finish line.  To send that last check (or bill pay payment) and then run into the streets screaming.  Some of us may even follow that up with a call to a certain Mr. Ramsey.  With any luck, most of us will reach that point sooner rather than later.

But, then what?  We’re done paying off debt.  We don’t need this silly budget thing anymore right?  And we certainly don’t need to be worried about how much we’re spending.  And so what if we leave a balance on our credit cards now and again.  Wrong.  Oh so wrong.  If your years of debt repayment hasn’t conditioned you to it already, you’ll soon find out that you still have to do all of that.  You might be able to loosen the strings a little, but keeping those habits is what will keep you from ever going back there again.

Just like any physical trainer will tell you; if you want to keep in marathon shape, you’ve got to keep maintaining your fitness. You can’t expect to stop and then still be able to run another marathon. In short, you’ve got to keep on the treadmill.

With all of your debt paid off and only your monthly expenses to worry about, you’ve got to get on “the Debt Free Treadmill”. You’ve got to use it to keep your self in financial shape. However, in this case, it is so you never have to run that marathon again. Debt is an easy trap to fall into. It only takes one lazy month to leave a little balance on a credit card and start the cycle all over.

Get on “the Debt Free Treadmill”!  Keep yourself in financial shape by continuing the same habits of saving, budgeting, investing, and frugality that you used to finish that marathon.  Use it to your advantage.  Unlike a large majority of the people in this world, you aren’t running that marathon.  Best of all, you get to use that financial fitness to benefit others.  Share your knowledge, and help people reach the marathon finish line so that they can jump on “the Debt Free Treadmill”!

Image Credit: Treadmill Workout by sirwiseowl, on Flickr