Prosper.com is a Bad Investment So Far, Part 1
In March 07, I decided to try out Prosper.com. Prosper is a peer-to-peer marketplace for loans. The allure of Prosper is that you can loan out money at high interest, much higher than a savings account. But there a number of problems with Prosper.
1) Prosper interest is taxed as regular income. Compare this with a stock market investment (e.g. an index ETF like SPY or EFA) where the dividends are taxed at a lower rate and you don’t pay capital gains taxes until you sell.
For me, the marginal tax rate for Prosper interest is about 30%-40% (5% New Hampshire + 25%-35% Federal). Equity investments are taxed at a much lower rate; my marginal rate for dividends is about 20% (15% Federal + 5% New Hampshire) and I rarely sell the index ETFs so assume no capital gains tax there. To net out the tax rate for equities, assume the equities throw off 2%-3% in dividends which are taxed at 20%. So the marginal tax rate for equities is 0.4%-0.6% if I don’t sell and create capital gains.
According this chart, the S&P500 has had an 11.2% annual return from 1970 to 2006. Given my tax rate assumptions, Prosper money would need to be lent out at 17%-18% interest to match the after-tax return of the stock market.
According to the performance page on Prosper’s web site, most of the loans on Prosper are generating lower pre-tax returns than the S&P500. This would be fine if the risk was lower than the stock market. We’ll look at risk in Part 2.