Over-Diversification on Prosper is a Bad Thing
I have a bit of money invested in some Prosper loans now and am interested in how they are doing, as well as how the whole concept of Peer to Peer lending is going. The ProsperDays conference has been going on the past couple days and I’ve been watching some videos of it. I thought this one was interesting with some of Prosper largest lenders offering their advice.
About 4:12 into the video, this lender says common wisdom in the Prosper community is that diversification is a good thing (and it is). But, people take that a step farther and think ‘If diversification is a good thing, more diversification must be better’ - which is not necessarily the case. I happen to agree with him.
The key is that when lenders diversify too much, they are bidding on loans with lower rates of return, so their overall profitability goes down. If you only bid on the loans with the highest rates, you will be outbid more often, but will end up with only the highest rate loans.
| Amount To Loan | $10,000 | $10,000 |
| Loan factors | Same Loan Qualifications | |
| Minimum Interest Rate (Range of 10-20%) | 10% | 18% |
| Avg Interest Rate | 15% | 19% |
| Loans Bid On | 200 loans at $50/each | 50 loans at $200/each |
| Default Rate | 5% | 5% |
| # Loans Defaulted | 10 | 2.5 |
| Forumula | (10000 - (200 * 0.05 *50) * 0.15 | (10000 - (50 * 0.05 * 200) * 0.19 |
| Return | 14.25% | 18.05% |
I’ve adopted this strategy in my own bidding. I have a portfolio plan (was a standing order) that bid only on AA and A quality loans that are above 12%. I still bid just $50 each on them instead because I don’t have that much free money to put into them. I end up bidding on a relatively large number of bids that are ultimately outbid, but I’m okay with that because I’m not investing in many of the loans that fall down into the 8-10% range.
