One of the side effects of the atrocious market we have endured in recent months is incredibly low interest rates on deposit accounts. Bank savings accounts are earning less than 1% yield, and even traditionally higher online savings accounts, such as ING Direct, are only offering 2.75% APY at the time of this writing.  What’s a conservative-leaning investor to do?

If you are up for taking on slightly more risk for the chance of a lot more reward, the peer-to-peer lending industry might be the place for you.  I was admittedly skeptical when peer-to-peer lenders first came on the scene, but the more I’ve learned about the industry, the more I appreciate its ability to cut out the middle man (banks).

What is Peer to Peer Lending?

Peer-to-Peer lending involves investors pooling their money to fund loans for borrowers in the private market.  Interest rates vary according to the credit risk for a particular borrower, but it isn’t uncommon for investors to earn over 6% or 7% on loans for those with good credit, and much more on riskier borrowing prospects.

One of the aspects of peer-to-peer lending that appeals most to me is the fact that banks are cut out of the lending cycle and power is pushed down to the average citizen.  Perhaps it appeals to my entrepreneurial spirit.  I might not be able to fully fund your $10,000 debt consolidation loan, but I can pitch in $100 along with dozens of other investors.  This helps spread the risk around a bit so that no single investor is heavily leveraged in any one loan deal.  It also provides borrowers greater opportunity for receiving a loan in this tightening credit market.

Borrowers are asked to fill out a profile including a compelling description indicating the reason they are in need of a loan.  This has a way of personalizing the request.  Perusing the current loan listings at Lending Club I see a variety of loan requests from debt consolidation, to a used car purchase, to a request for start-up capital to fund a new business idea.  Knowing that you are investing in someone’s dream is exciting!

Peer-to-peer lenders, such as Lending Club, also grade borrowers based on their creditworthiness including such factors as debt-to-income ratio, credit scores, etc.  Of course, it isn’t foolproof, and there are risks of defaults and late payments.  However, several well-placed investments in loans could make for a portfolio producing a much higher yield than other types of cash investments.

How Much to Invest in Peer-to-Peer Lending?

I personally treat this type of investing much the same way I treat single-stock investing; I don’t put more than 10% of my overall portfolio in either investment.  The bulk of my investing is for retirement inside growth stock mutual funds.  Outside of retirement funds I stash emergency fund cash away in an online savings account, and with any remaining cash I may dabble in things like peer-to-peer lending or investing in single stocks I feel good about over the long-term, and have a history of producing great dividends.

So like anything else I recommend here, don’t dump all your eggs in one basket.  Start small until you get the hang of social lending.

Interested in finding out more about social lending?  Join me over at Lending Club!

 
Photo courtesy of mvhargan

This guest post was written by ABCs of Investing - a brand new site for novice investors which offers two short and quick investing posts per week.  Feel free to subscribe to the feed.

How ’bout them stock markets?  Hmmmm…not so good?  Well, whatever you do - don’t wimp out and switch your equities to cash, however tempting as it might be.  Why is that you ask?  To answer that I’m going to go into one of the main lessons of the Four Pillars of Investing - know the history of the markets.  This doesn’t mean memorizing any boring dates or who was present at some document signing but rather taking a look at some past market bubbles…and more importantly, some past market crashes.  The idea here is to put that famous expression “those who cannot learn from the past are doomed to repeat it” to rest!

Investing in stock markets has a huge behavioural component to it - balance sheets and price/equity ratios are all fine and dandy, but the real question is - can you avoid pulling the trigger on the ’sell’ button when the markets take a nose dive?  Some investors talk of buying when stocks are “cheap” - don’t forget that not selling is the same as buying.  If you take a big loss on your investments and sell, then you have locked in your losses and have no chance of profiting from future stock market gains.

William Bernstein, author of The Four Pillars of Investing, has completed a lot of research which show how the stock markets always come back from the depths.  His advice is “when things look bleakest, future returns are highest“.

Let’s take a look at two examples from his book:

1929 stock market crash

This is undoubtedly the most famous stock market crash of all time - over the course of almost 3 years, the Dow Jones Industrial Average lost about 90% of its peak value from Sept 3, 1929 to July 8, 1932.  Needless to say, this event was quite devastating and many former investors swore off equities forever.  Investors who stayed in equities were rewarded however, since the markets returned 15.4% annually for the 20 years following the 1932 bottom.

1973-1974 crash

This market crash followed a period of great market returns due to the phenomenon of the “nifty fifty” companies.  Unfortunately the “fifty” weren’t so “nifty” after all and the Dow Jones lost almost half its value (sound familiar?) from the beginning of 1973 to the end of 1974.  Bernstein introduces an interesting statistic - in the late 1960’s, which was the middle of a huge bull market, 30% of American households owned stocks.  By the late 1970’s and early 1980’s which was after the big crash, only 15% of of households owned any stocks.  It is unfortunate that so many investors chose to leave the market when the going got rough, because the market returned 15.1% annually for the 20 years following the 1974 bottom.

Stock market prediction time

I’m no economist or stock picker but one of the interesting things I recently found out about the 1929 crash was that the Dow Jones had increased approximately 350% (not including dividends) in the 5 years prior to crash.  350% in five years is absolutely amazing and it shouldn’t be a huge surprise that a bubble had formed.  The aftermath of that bubble was that the equity markets lost 90% of their value (from the peak).  Is this happening again?  I doubt it, the returns of the US equity markets have been relatively modest in the past few years so it is hard to believe that a major bubble had formed.  My grand prediction?  The US equity markets will not lose 90% of their peak value, but rather a lesser number - hopefully much less.

Conclusion

Switching your equity investments to cash after they go down is not a good way to invest.  After events like the markets we have suffered through this year, there is nothing wrong with revisiting your asset allocation but the best thing you can do is to learn more about investing.  Study past market history, read investing books, blogs (especially this one) and keep track of your investments.  If you have an advisor then talk to them frequently and make sure you know what you are invested in.  Stock markets go up and down - the more you are prepared for it, the easier it will be to ride out both the good times and the bad times.

 
Photo courtesy of epicharmus

Here lately our markets have been in a tailspin with little reason to “pull up” and get us out of this dive.  It seems like there has been one negative bit of financial news after the other for weeks.  Many economists and politicians are fearing a recession, or worse.  In times of market turmoil I hear many pundits tossing around the phrase, “Cash is King!”  When stocks are losing money, 401(k) funds are being obliterated, and even the rock-solid money market mutual fund accounts were on shaky ground for a while, cash looked like a pretty good investment.  After all, a 4% interest is better than a negative 20% loss.

If You Are Not In the Market, Consider Cash

I’ve never been much of a stock market guy.  Most of my early career I barely made enough money to pay for school and a few miscellaneous expenses.  I did contribute to a 401(k) early, but only because my employer automatically enrolled us and made a matching contribution.  Over the years, I have learned more about the various types of mutual funds and am comfortable making investment elections for both my 401k and Roth IRA.  However, as I begin to dabble with savings outside of retirement plans, I can’t help but wonder if cash really is king.  Maybe an ultra-conservative mix of high-yield savings accounts, CD ladders, and treasuries really is the way to go.

It is easy to look like an expert by recommending cash in a bear market, but what about when times are good?  In years past where stock mutual funds were averaging 25% growth it seemed ludicrous to keep cash on the sidelines earning 4%.  However, when stocks are down 25% the idea of earning a guaranteed 4% is attractive.  We know historically that the market will go up over the long term, but it is these short-term sell offs that make stock market investing so painful.

If You Are Already In the Market, Stay the Course

I do not believe in pulling all long-term investments out of the market.  Jim Cramer recently took some heat for suggesting that investors take money out of stocks if they will need access to the money in the next five years.  On the surface, his comments sounds pretty gloomy for the immediate future of the market, however what he suggested is what virtually all financial planners suggest.  It is generally a bad idea to invest money in the stock market if you plan to use it within the next five years.  This recent downturn is a good reason why that is sound advice.  Five years simply does not allow enough time to recover from these types of hits.

So how does one ultimately decide whether or not to invest in the market, or in cash?  The answer lies in determining your tolerance for risk.  If you are a risk-taker, and have time on your side to ride out some of these short-term storms, then you are probably safe to invest in the market.  However, if you are not a big risk-taker, or are already nearing retirement, cash may be the most attractive option.  Of course, you may miss some growth when the market rebounds, but at least your capital will be relatively safe in the short-term.

 
Photo courtesy of Banalities

Investment advisers often give the advice to get defensive when times are tough.  Investors typically run to sectors like health care, defense, and consumer staples.  On September 29, 2008, they ran to only one stock on the S&P 500.  That’s right; every single member of the S&P 500 lost money that day, but one lone gainer.  Campbell Soup Company, the ultimate frugal culinary staple, actually increased shareholder value that day.  So what’s the lesson?

Frugal Living is Making a Comeback

Between increased sales of Spam and Campbell’s silver lining on an otherwise dark day, it appears frugal living is making a comeback.  The evidence is incontrovertible, but the jury is still out on the reason behind people’s new found affinity for all things frugal.  Is it because they don’t have a choice?  Perhaps.  In some cases I imagine people have little choice regarding spending decisions.   When we are in budget stretching mode around our household, soup and grilled cheese sandwiches are as popular as steaks and baked potatoes.  Even if people can afford to make more luxurious purchases the market turmoil has consumers running for the soup aisle because suddenly other money goals take a priority.

Of course we won’t know if sales of Campbell Soup are really higher during this period until quarterly reports are shared.  I think the soup-maker’s ability to rise to the top when the other 499 members of the S&P 500 were getting hammered is indicative of just how shaky things are, economically.  It is almost as if investors had given up on every other sector, every other company, and said, “The only thing that will survive this collapse is gool ol’ Campbell Soup.”  Just like that hearty cockroach behind the fridge (I know, bad analogy), Campbell was the only one strong enough to survive such a nuclear sell-off.

Does This Mean the End of Luxury?

Yes, probably in the short term.  Of course, there will always be an element of the population that can afford $1200 purses and $60,000 cars, but for the average person the option is no longer there to stretch for such conspicuous consumption on borrowed money.  Times of living the good life compliments of the Visa card are over.  While this will create some short-term pain in the market, particularly for high-end retailers, it is probably a good thing.  People have been financing too much of their lives in an effort to live way beyond their means.  It’s about time we got back to the basics–spend less than you earn, save for a rainy day (and a sunny one), and eat more Campbell Soup for dinner.  Anyone have a coupon?