Building wealth is simple when you understand the rules. Spending less than you earn provides seed capital for investments. Index funds provide the opportunity for superior growth with reduced risk due to diversification across the broad economic spectrum.
Once you have the basics it becomes clear you need additional cash management tools to serve your financial needs. Short-term cash for emergencies or living expenses are best held as bank deposits or in high-yield accounts like Capital One 360 or Discover Savings.
With long-term investments set in index funds and short-term needs covered by liquid money market type products it’s time to fill in the remaining gap. And there are some reasonable alternatives paying a respectable rate of return.
Business owners understand the need for liquid fund to cover seasonal fluctuations. In my office tax season fills the coffers used during the slow times of the year. November and December are traditionally slow in the tax industry while expenses tend to be high. Some year-end tax planning brings in some revenue, but the cost of mailing organizers, employee training and property taxes take an ax to the budget. This is the gap I refer to above.
Individuals face the same gap. Planning for a vacation or allocating funds for property taxes are an example. Individuals may also become uncomfortable with the level of the stock market. Selling index funds to store in a money market at a percent or two doesn’t make sense and becomes painful when the market continues climbing.
I never encourage market timing. However, there are times to take some chips off the table. Example: As you approach retirement (or if you are in retirement) I always recommend keeping about two years of living expenses in cash. If the market keeps climbing you can fund living expenses with dividends or small index fund sales. When the market has a temporary setback you can use the liquid funds to live. This assures you never have to sell at a market low! If the downturn becomes prolonged you can stop reinvesting dividends and capital gains to fund expenses. The goal is to never find yourself forced to sell in a down market.
Investing Gap Funds
Money market funds and online savings accounts at Capital One and Discover are good tools to store excess funds in retirement, for future investments or to pay large one-time expenses. The interest rate is low, but better than nothing.
For several years I used Lending Club and Prosper (notice I don’t include links because I no longer recommend these options) to serve as a high-yield investment for such funds. Then we had the Lending Club fiasco I was out the door. Where there is smoke there’s fire. I could be wrong, but I’d rather be a living coward than a dead hero.
Lending Club and Prosper issue unsecured loans you can invest as little as $25 in. The goal is to spread your investment over as many loans as possible to avoid one bad loan destroying your portfolio. There are lots of loans that default as borrowers have no skin in the game.
Peer Street offers loans in a similar fashion to the Lending Club/Prosper model with a few notable exceptions. Peer Street loans are backed by real estate with loan to value (LTV) typically below 75%. Borrowers have skin in the game!
The minimum investment is $1,000 per loan. This is still a micro loan, but not nearly as small as the $25 minimums at Lending Club or Proper. Since there is something backing the loan (real estate) the risk is likely much smaller. (Loans backed by assets default at lower rates than unsecured loan with rare exception.) You can still—and should—spread your investment funds over several loans to mitigate risk. (More below.)
Most Peer Street loans are short term (6-24 months) and generally yield 6-12% over 12 months. Peer Street periodically has very short loans (one month) that yield a lower rate, but more than Capital One or Discover currently. This can be a powerful cash management tool.
The short-term nature of the loans makes it easy to ladder your portfolio for consistent cash flow and liquidity. A small investment can provide a steady stream of available cash while earning a higher than average yield.
How I Use Peer Street
I don’t like to over-commit to any investment. My style is to dip my toe in the waters first and then stepping slow into the shallow end until I’m comfortable.
I started investing in Peer Street a few months back. Every loan I invested in is for the minimum: $1,000. So you understand my style, I currently have $6,000 invested with intentions of reaching $100,000 over the next year or two. As long as the wheels don’t fall off (remember the Lending Club issues) I’m happy. I’ll never put everything into Peer Street, but I will invest enough to move the needle eventually.
Every week or two I’ve been adding another $1,000 or so. Peer Street reports interest income and loan maturity funds on the 15th and last day of the month. The money appears in my account a few days later. I use this opportunity to add new funds to my account to bring the cash balance back to $1,000 so I can invest in another loan.
My slow approach is for two reasons. First, I can sample how Peer Street works before committing a level of funds that would hurt if I misstep. This allows me to acclimate to the investment. Second, the slow approach means I have loans spread out over a wide range. In a few months I will have loans maturing practically every month. Coupled with the interest stream I’m in a good position to benefit from the investment.
Investing in income properties can be a lot of work with plenty of risks. Peer Street makes real estate investing easier, smoothing the income ride along the way.
Interest income is taxable. Landlords have several tax advantages due to real estate ownership. Peer Street investments are loans and income is treated as ordinary income. If you are familiar with Lending Club or Prosper you will find reporting Peer Street income looks a lot the same. The main difference is loan losses. Lending Club/Prosper have a lot of loans that default. This can play havoc on your tax return in some instances. Peer Street has had a few loans default, but according to a conversation I had with a Peer Street consultant on the phone, investors lost no money. The LTV metric does offer a level of protection to investors. (Loan losses would be handled in a similar fashion to Lending Club should they occur.)
Time for a reality check. Most loans offered on Peer Street hover around 7%. Yes, the sales literature says you can pull up to 12%. Real world experience says you will have plenty of opportunity to invest with a 7% return. Some loans are lower, more are higher. Loans paying 8% or more require a strategy.
Peer Street allows for automatic investing of funds in your account. What I do is keep $1,000 in the account and set the parameters of the auto-investing feature at 8% or higher, LTV up to 75%, loan term up to 60 months (I don’t mind a longer term investment, but you may wish to tighten this parameter) and $1,000 max per loan.
Peer Street sends an email when they invest in a loan automatically. If you don’t like the look of the loan you have 24 hours to cancel from time of notification.
New loans are available most business days. The higher interest loans usually are filled with automatic funds. The 7% and 7 ½% loans are frequently available for manual investing.
There you have it, kind readers. No fancy stories today. This is an idea I’ve been working personally on a small scale for a bit and wanted to share it with you. As a reminder, the links in this post are affiliates. Peer Street graces your favorite accountant with $30 for every new account I send their way. I have affiliate links for Prosper and Lending Club, but do not include them because I no longer support their programs. I’d rather be safe than sorry.
I can’t make a real recommendation for you personally since I don’t know you personally, along with all the relevant facts. My only recommendation is to take it slow if you find Peer Street appropriate for your portfolio. No heroes; just another nice product to handle funds living in the gap.