Can I achieve the effective interest rate? YES!


  • Funding Societies

    A simple but powerful tip to increase your p2p return

    One of the easiest way to increase your p2p return is to keep reinvesting. Once your repayment comes in, reinvest the cash into new loans. This way, your money is always working hard for you. If you do not reinvest, your repayments are simply earning zero return.

    Some p2p investors emailed us and asked why we use effective interest rate instead of simple interest rate. They seem to think that effective interest rate is not real, and actual return is most accurately represented by simple interest rate. No, no, no… They are mistaken. Effective interest rate is achievable. Just that it is difficult to do so with just one loan. If you have a decently sized portfolio and reinvest diligently, you can get the effective rate. In fact, that is exactly what a lot of our investors are doing with their p2p portfolio. To understand how this works, we need to go through the math in one example.

    Example

    Suppose you invested $2,000 into a Funding Societies loan (let’s call this Loan A) with the following details. The most important information is highlighted in the red and blue boxes.

    Annual percentage rate is also known as the effective interest rate. It refers to the return as if your money is always fully invested (or reinvested).

    Annual effective yield is also known as the simple interest rate. It refers to the return as if your repayments are never invested (or reinvested).

    0_1508390567286_Screen Shot 2017-10-19 at 12.10.13 PM.png

    The blue box shows the monthly repayment that you (as an investor) will receive, after deducting for platform fees. If you invested $2,000 on this loan, the repayment schedule will be as follows (simply divide each repayment amount in the above blue box by 50).

    0_1508390798060_0345db15-1098-4887-8ce7-0cb607886941-image.png

    Scenario 1: Invest $2,000 in Loan A and let each repayment sit idle as cash

    By the end of 12 months, you will have $2,260.44. This means your ROI (return on investment) is just 13%, the same as the simple interest rate.

    Scenario 2: Invest $2,000 in Loan A, and after 6 months reinvest in a second loan, Loan B

    By the end of 6 months, you decide to invest in a new 6-month loan (Loan B). The details of Loan B are as follows.

    0_1508390850195_147fd5fe-7a3b-4ded-9010-eb7f1ad5a7c6-image.png

    As before, the repayment schedule of a $1,000 loan can be worked out easily (simply divide the repayment amount in the above blue box by 100).

    0_1508390877809_a0851ec0-08ee-49fb-a340-634d6f70bfd6-image.png

    The trick comes when you reinvest the repayments of Loan A into Loan B. Note that there is no new money. Your total investment is still $2,000. But after 6 months, you would have gotten back $1,116.02 from Loan A. With this, you can reinvest $1,000 into Loan B. The repayment schedule of these two loans are shown below.

    0_1508390907976_88c6e32b-66c1-47a8-93a7-9af8820185d7-image.png

    What happens now is that your money is now working twice as hard as before. And your ROI has now climbed to 15.9%, from 13.0%, for the same 1 year duration.

    What if you reinvest another $1,000 in month 9, and another $1,000 in month 11? Well, you already know the answer, your ROI will keep climbing. Because your money is working overtime for you!

    The theoretical limit for ROI is the effective interest rate. If you have a sizeable portfolio and manage to reinvest every repayment perfectly, you will be able to achieve the effective interest rate. Of course, don’t get too carried away. Also remember to diversify and watch the credit of each loan.

    This article was originally published in letscrowdsmater.com. Link to the original article: http://letscrowdsmarter.com/simple-powerful-tip-increase-p2p-return/


 

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