Over the past 8 years, I have invested over $16,000 with Lending Club. In the beginning, I was earning 10% annual return, beating the stock market, and I was very impressed with service. But as time went on and I learned more, I became much more skeptical.
About a year ago I’d had enough. I stopped investing with Lending Club and since then I’ve been pulling money out as quickly as possible.
My three main reasons for leaving are: the returns were not as good as I originally thought, income tax eats into the returns, and the opportunity cost of not investing elsewhere became too high.
By far the biggest disappointment is that the returns on my Lending Club investment have been lower than expected.
I made my first investment in May of 2009. I created a highly diversified portfolio by only investing $25 in each loan. Over time, this gave me exposure to more than 1,600 loans, spreading out my risk over hundreds of loans.
Lending Club rates the quality of their loans from A to G, and I often invested in the riskier E, F, and G loans. Although these loans are riskier, they should come with higher returns for a long-term diversified portfolio like I was creating. Lending Club’s own website even tells the user these loans offer “More Risk/Higher Return Rate,” so I felt that my money was invested for the highest return over the long run.
I also felt confident because Lending Club claims you will earn 4-6% on your investment. That’s a solid return, and I was even more confident that my high risk/high return portfolio of grade E, F, and G loans would do better than that 4-6% average.
I was wrong.
What I didn’t notice at the time is the fine print that said the 4-6% average return is only true for grade A, B, and C loans. The grade E, F, and G loans that I was invested in were a higher risk without the higher return. So much so that Lending Club discontinued grade F and G notes in 2017 because they had failed to properly model their risk.
According to Lending Club’s own statistics, during the time I was invested, my portfolio of E and F/G loans averaged returns of 4.67% and 2.61%, respectively. No bueno.
Even if I had invested in grade C loans (Lending Club’s top performer) and earned 6% during those years, my real returns would have been much worse because of taxes.
Income Tax Eats Returns
Unlike investing in stocks, interest from loan payments is taxed as ordinary income, which is a much higher rate. This means more of the money you make from Lending Club goes into Uncle Sam’s pocket.
I live in California, and the combined federal income tax plus California state income tax for most people (earning $40k – $155k) is between 31-33%. This is significantly higher than the long-term capital gains rate of 15%, which is what you pay if you hold a stock for more than a year before selling it.
If we look at how this affects your return over one year (assuming the stock market and your Lending Club investments each earned the same 7%), it becomes clear that despite the “same” 7% return, because of taxes, you actually earned 27% more in the stock market!
But what makes this even worse is that the math compounds. Because you have to pay income tax every year, the increased ordinary income tax rate eats into your real return every year.
If instead, we look at a time horizon of 10 years, you can see that this “same” 7% return isn’t the same at all – investing in the stock market earns you 41% more, after taxes.
(If you’re curious about the math, here’s a spreadsheet with all these calculations.)
Opportunity Cost Too High
Even if you get the 4-6% return Lending Club advertises, and even if you ignore the tax inefficiencies of loans being taxed as ordinary income, at the end of the day there are just better places to invest your money.
Stocks have historically offered a 7% return, and over the past 8 years, we’ve seen a record bull market with the S&P 500 averaging over 13% annual return. Even a good dividend index fund pays out 3% every year while still giving you the upside of appreciation.
Another option is real estate investing. Although it requires more up-front capital, buying a rental property through a hands-off, fully-managed investment service like HomeUnion or investing in a diversified portfolio of private real estate assets through Fundrise can each net you annualized returns north of 10%.
At the end of the day, it’s up to you where you invest your money.
I would encourage you to steer clear of Lending Club for all the reasons outlined, but if you do decide to invest just make sure you’re totally aware of what you’re getting into. I certainly wasn’t, and had I known all that I do now, I would have made a much different choice 8 years ago.
Disclaimer: this post is based on my personal experience and should not be taken as financial advice.