Military Retirement & Financial Independence

Reserve retirement and the blog’s top ten posts

June 17, 2013 by Doug Nordman · 3 Comments

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Last October I moved the blog from WordPress.com to Bluehost. By then I’d been blogging about financial independence for two years. The blog had reached nearly 122,000 pageviews and about 7000 views per month. Certain posts had bubbled their way up to the top of the reader rankings.

Top ten posts after two years of blogging.

Lifestyles in retirement: cable TV troubleshooting

June 13, 2013 by Doug Nordman · 8 Comments

I’ve blogged before about how do-it-yourself home maintenance can accelerate your goal of financial independence. (See the related posts below.) Unfortunately sometimes you have to put down your tools and seek professional help. My spouse watches a lot of HGTV and we spend a lot of time on DIY websites, but I’m weak on TV & telephone infrastructure.

Our cable TV choices in Hawaii (to put it politely) suck. We live in a cul-de-sac at the very far end of a long string of hundreds of cable customers, so we get the weakest remnants of the signal. We’re also at the bottom of a hill, and all the rainwater flows past our property into the storm drain. We use two TiVo Series 2 digital video recorders (with lifetime subscriptions) that work well with analog cable, not so well with satellite or digital cable.

When we moved into this house 13 years ago, we fell into a familiar pattern. My spouse would be watching TV (Oceanic Time Warner Cable analog service) and I’d be geeking away on the computer (RoadRunner). The signal would start to splutter. First I’d have trouble with downloads, and then she’d have trouble with static on the higher channels. Eventually conditions would deteriorate to the point where I wouldn’t be able to get online and she’d barely be able to watch any of the channels.

After a year or two we noticed that Hawaii’s winter rains were correlated with this problem. When it really rained hard, or when it drizzled steadily for several days, we’d start to lose service.

The cable company’s customer service staff was never sympathetic. Long hold times were common and the script’s questions were barely above a fifth-grade level:

“Is your computer turned on?”
“Is your modem turned on?”
“Is your TV turned on?”
“Is your cable box turned on?”

Then I’d get the suggestion that would really fire me up: “I’m sorry, sir, but we have no other complaints in your area. Maybe you should check with your neighbors, because the problem seems to be in your house.”

People used to wonder what we early retirees do all day. As a nuclear-trained submariner, I have graduate degrees in persistence & tenacity. I’d stay on the phone with the customer “service” people for up to an hour, patiently and politely working up through several levels of supervisors (with progressively more annoying questions) until they’d send out a tech. I’m sure the cable company made a little note in my file, because subsequent calls would be greeted with the attitude of “Oh, it’s you again…”

The techs were pretty good (compared to the customer service staff) but their job seemed to be to do as little work as they could get away with, and as quickly as possible. For the first couple of years this consisted of replacing cable connectors at the house and installing a small RF amplifier. Eventually one of them traced a signal loss to the street box in the sidewalk, which was full of water after the last rainstorm. He replaced a connector there, but that improvement only lasted another couple of rainstorms.

After several years of phone calls every few months, Oceanic Cable and I burned out on each other. The techs claimed there wasn’t much else they could do. After the connector replacement the cable signal never got really bad again, but it was never very good. My phone calls were met with stonewalling: “We’ve done everything we can” and upselling: “Would you like to upgrade to our digital service?” In 2004 we gave up on RoadRunner and went with DSL from Hawaiian Telcom. We kept the analog cable service because it was barely good enough, but every rainstorm we’d lose signal quality for the day– until things dried out.

We eventually decided that this was as good as it was going to get. I don’t watch much TV, and apparently my spouse was willing to put up with substandard cable instead of no cable. This standoff continued for over eight more years.

A couple of months ago we had a torrential downpour and the cable signal suffered its usual decline. However four days later it was still full of static, so we finally started troubleshooting. We’ve accumulated a huge supply of co-axial cable after two decades of military moves, so we connected a cable directly from the cable company’s service connection (outside our garage door), dragged the cable through the house, and plugged it directly into our DVR. The signal was a little better (so our cables in our walls were losing a little signal strength) but still not good enough to watch. I plugged in another RF amplifier and the signal got a little better, but it took 14 db to get from “no signal” to “barely viewable”. 14 db is a lot of signal amplification, so we knew we had a real problem this time.

Next morning we called the cable company as soon as they opened for business. After eight years I had to start all over again. I endured the usual interrogation to establish that I’m not an idiot, and that nobody else in our neighborhood had complained. I told them that our cable box in the street was full of water. They agreed that was a problem, so they’d be able to send someone out during the afternoon of the next day. We volleyed that negotiation back & forth for a few more rounds and decided that they’d call us if they had an opening later that day. When you’re retired, you can spend all day waiting at home for the cable guy.

The old cable TV street box

The tech finally showed up at 3 PM and agreed that our service connection at the garage looked a little old. He understood that we were at the end of the string and might need a little more signal strength than the usual cable customer. Then he opened the street box in the sidewalk and saw that the ground was still damp (four days after the last rain). He unscrewed the cable from the connector box, and water dripped out. (Cable boxes aren’t supposed to drip anything, let alone water.) He saw that the coax cable’s center wire was actually rusted, so he cut off a few inches of the cable and tried to put on a new connector. (Just like all the other times.) However the 23-year-old cable was so brittle that he couldn’t get a good fit. When he went to the garage service box to fix that connector, he couldn’t get a good connection there either. He was almost out of cable slack, and fine beads of sweat were beginning to pop out on his forehead, so he decided to replace that whole 50-foot stretch of cable.

He tried to stick a fish wire down the conduit between the street box and the garage service box, but the fish kept getting stuck. He called for backup tech support, and a few minutes later a second truck showed up. They squirted a few pints of soapy lubricant down into the cable conduit, added several gallons of water from our garden hose (flooding the street box again), and were finally able to move the old cable. Then they pulled over 60 feet of shiny new coax cable through the conduit (under the sidewalk, under our driveway, and up to the garage) and put on new connectors.

Water damage to electronics inside the cable TV connector box

The inside of the cable TV street box

Meanwhile a third truck showed up to help. That tech went to the street box and checked the neighborhood cable’s signal strength to the connector that had been dripping water. After a few choice four-letter words, he unscrewed the bolts on the connector housing and pulled it open. Water poured out, and it looked as though they’d finally identified the root cause of the last decade of problems.

You don’t have to be a submariner or an engineer to recognize what water has done to these electronics. Believe it or not, the filtering circuitry had still managed to let through some signal over the years– until it turned into a solid block of rust.

The techs used an impressive power tool to cut the cable and put on a new connector. At this point I was really glad I’d sought professional help, because I wouldn’t even have wanted to try to fish in a new cable.

Just by replacing the connector in the street box they gained 18 db of signal strength. They guessed that the new cable from the street box to the service connection was another 3-6 db improvement. I unplugged our 14 db amplifier and reconnected the regular house cable to the DVR.

New connector and new cable to house.

It’s amazing. No static anywhere. All the channels are totally clear. The coax cable in our house’s walls may be old & brittle, but there’s more than enough signal strength to handle it. It’s amazing what crappy service (both cable signal and customer support) we’d become resigned to during all those years of frustration.

We’re still at the end of a long string of customers, but we seem to have plenty of power. The seals on the new box should last for at least five years, and now I know what to watch for. I’m even considering going back to RoadRunner. If the signal is this good we could ditch our Hawaiian Telcom landline and go to digital phone service. Our cable bill is “only” $70/month, and our combined telephone landline/DSL bill is “only” another $55/month, but now that we have good cable again it’s time to shop around.

Maybe I need to get out my 100-foot roll of RJ-11 phone wiring and start troubleshooting our DSL signal too. And if HGTV ever moves to Hulu (or Netflix?) then we might be done with cable TV.

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Filed Under: "What do you DO all day?!?" · Tagged With: cable TV, early retirement, financial independence, home maintenance, Home repair, military

5 Ways to Ease the Transition from Military to Civilian Career

June 12, 2013 by Aaron Walker · 2 Comments

This guest post is brought to you by Aaron Walker.

(If you’re interested in contributing a guest post, please see our guest posting guidelines.)

I’ll be honest: When I began the job search as I moved from the military to civilian life, I often felt like I was speaking a different language than the people who interviewed me. I’d detail my experience with military terminology and often drew blank looks from interviewers who had no idea what I was talking about, or how I could fit in at their company.

It left me feeling frustrated and, I’ll admit, and a little defeated. Add in a terrible economy, and I wasn’t sure I would ever find work in any field, whether it be food service or human resources translations.

Luckily, that turned out to be wrong. Eventually, I found a great position. These five tips can help you, too, make the often rocky transition from a military to civilian career.

Speak the Same Language

There are a lot of terms that we throw around in the military that are second nature to us, but civilians don’t understand them. Do a practice interview with a civilian friend and have them help you hone in on what words you’re using that might be confusing. Remember this during your real interview, and try to explain yourself in a different way. The less confused the interviewer is, the better chance you have of getting the job.

Be Your Own Cheerleader

In the military, we’re not used to putting ourselves first. We do things for the good of our unit. But in civilian life, it’s the opposite. If you don’t tell an interviewer how great you are at making donuts or crunching numbers, they’re not going to want to hire you. Don’t be afraid to brag about all the things you do well.

Get Help

Many of us in the military tend to think that reaching out for help shows weakness. It’s not true. Sometimes a helping hand is just what you need to get on the right track, and it could be the difference between finding a job and heading back to the unemployment office. There are lots of great government-sponsored programs that help veterans find jobs. There are also local and regional programs that can help you get your foot through the door.

Have a Realistic Outlook

A study by Prudential Financial and Iraq and Afghanistan Veterans of America found that 80 percent of military job seekers are looking for “the right job” rather than just any job. That may be setting your up for a failure. If you have your sights set too high, you won’t see what’s right in front of you, which could be the perfect job if only you’d lower your standards a bit.

Revamp Your Resume

Military resumes tend to be too long for civilian employers’ tastes. It’s a great idea to give your military resume a pruning. Make sure to define any acronyms that are included in it, even something as basic as D.O.D. Though you assume everyone knows that’s “Department of Defense,” not everyone does, and rather than take the time to figure it out, they’ll just toss your résumé in the slush pile.

Aaron Walker is a former serviceman who now works in translation and freelance writing.

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Filed Under: Finances · Tagged With: civilian, early retirement, financial independence, military, transition

“I’m setting a good example by working at a job”

June 10, 2013 by Doug Nordman · 4 Comments

I read an interesting forum thread about the conflicts between living life on your terms or meeting society’s expectations. When you reach financial independence and can choose whether or not to work for a paycheck, there may still be other issues affecting your employment decision.

Here are some (anonymous, edited) quotes from the post that started the discussion. The quotes eloquently state the issues faced by so many military veterans:

“By most people’s standards, I could retire if I want to. We’re financially independent.

I’m in my 40s. My wife and I have no debt other than our mortgage. We have investments in the stock market and I’ve always lived well below my means. I have a military pension and another source of passive income (outside of my investments) plus military health insurance.

My dream used to be to never work after I left the military. Somehow that didn’t happen.

The reasons:

I’m not sure what I would fill my time with.

My job doesn’t drive me crazy, maybe because I refuse to let it do so. I get paid fairly well for a job with not much stress and steady hours. I get every weekend off, plus every other Friday (thanks to a compressed schedule), and you can set your watch by my arrival time home every day. Between vacation time, every other Friday, holidays, and vacation days, I get 160 days off per year. I like to focus on the positives of that, and not the 205 other days per year. I have a long commute, and I’m not solving world hunger, but, that’s not so bad. If I can’t be happy with 160 days off per year, I probably can’t be happy with 365 days off per year.

I inherited a small amount of money from my dad and would feel like a freeloader if I didn’t pass on the same amount to my kids.

I think I owe my kids the example of getting up and going to work and being successful in the world (not just hanging out in my shorts all the time) before I one day tell them to go out into the world and bag a bunch of money. They were young when I was in the military and never really saw me work my butt off. Most of that happened before they were born or really aware. In the military I worked days on end, every holiday, every hour on the clock, 24 hours straight twice, and almost “gave all” one day in Iraq. We moved 13 times in 21 years.

I don’t think my spouse and I have an agreement of what “the dream” looks like. I used to dream about sailing around the world but one day I noticed my spouse likes a house with air conditioning, screens on the all the windows, heat, and other conveniences.

So I focus on finding as much joy as I can every day while still working, trying to enjoy what I have without becoming consumerist. I’m raising my kids to grow up with a healthy attitude to work and a sensible attitude about what money buys and what it doesn’t buy.”

I’ve seen several variations of this discussion over the last decade, so here are some thoughts to consider as you make your own transition.

“Filling your time”

In Malcolm Gladwell’s book “Outliers” his ideal occupation includes autonomy, complexity, and fulfillment. Personally if I was a doctor, lawyer, university professor, or financial advisor then maybe I’d see no reason to quit working. (However I saw no reason to start those careers, either.) Writing certainly delivers those three factors to me, although if I was doing it for profit then I’d be a starving author.

All retirees worry about “But… but what will we DO all day?!?” There’s not much comfort from trite answers like “Whatever you want!” or “Every day is Saturday and every night is Friday night!”. Those answers state the facts, but they’re just not detailed enough to be reassuring. Most military veterans have spent an entire career with their operating tempo at max throttle, and they’re not even able to imagine slowing down. Add in the clichés of “golfing all day” and “rusting rocking on the front porch“… there doesn’t seem to be much to look forward to.

Yet six months after these worried veterans leave the workplace, every retiree with whom I’ve spoken has said that they wonder what the heck they were worrying about. They’re finding plenty of autonomy, complexity, and fulfillment in their lives without having to go to the office.

The reality is that your retirement days will fill themselves. You already have your own goals along with the military skills and the personal discipline to make it happen. You’ll sleep better and you’ll be able to exercise “when you want” instead of “when there’s time”. You have a home to take care of (and maybe a yard) and you know how to build a maintenance task list. Your military occupation might translate directly to “handyman” or “domestic executive”, only without ammunition or midwatches. “Weekend duty” becomes “family time”. You might enjoy cooking & cleaning, or you’ll find a way to minimize the chores you despise. You’ll spend more time with family, neighbors, & friends. You’ll spend more time relaxing with a cup of coffee to read a book. You can run your errands at 9:30 AM on a Tuesday (while the rest of the world is at work or in school) instead of with the weekend crowds.

You’ll explore your interests whenever you want, and as much as you want, without having to get back to work and empty your IN box. This could be more of a problem than you might expect: when you’re responsible for your own time then you’re in charge of your own schedule. During your working days when you had too much to do, you could blame it all on work and the boss. If you overcommit yourself during retirement then you have only one person to blame.

If you’re still concerned about filling your time, author Ernie Zelinski has you covered: you can jumpstart your thinking with his “Get-A-Life Tree”. It’s a straightforward mind-map of your interests and ways to turn them into activities. I’m pretty sure that it works because I’ve had a blank copy on my desk for over a decade. I’ve never made the time to sit down and fill it out because I’m too busy doing other things.

The job’s not THAT bad

Military veterans have plenty of employment challenges before we even hang up the uniform, and you’ve probably already read about them many times in the media. I’m not going to repeat the common ones here, but there are two which you don’t read about very often.

The first issue is a powerful internal motivation to serve. When you’ve been taking care of the mission and your troops for years, even decades, then it’s hard to turn off that compulsion. We military veterans have a commitment to service. After the military you’re not only looking for a new purpose in life, but you’re also trying to find a cause and a group of people to take care of. When you’re financially independent you may still find yourself serving with nonprofits or the schools or local government. You’re not alone, either– retired civilian corporate executives also struggle with the constant desire to lead a major project with a big group.

The second issue is a little more controversial: the military inferiority complex. We’re our own worst enemies, and we all do it to each other. For years you’re told that you’re barely capable of functioning adequately at your current rank, let alone worthy of a promotion. Even when we’re alone we have a little internal drill sergeant that’s critiquing our performance. I’ve watched a senior submariner O-6, a future admiral and an instructor of other prospective commanding officers, tell his dozen steely-eyed killer-of-the-deep students “You’re never as good as you think you are, and you’re never better than your next mistake.” We may be in the military’s top units with the nation’s best people, and we’ll still beat ourselves up over every error. It’s a relentless drive for perfection that’s been keenly honed by centuries of combat, and it’s a type of teamwork that’s been elevated to an art form. It keeps us humble and it keeps us alert for surprises or ambushes. It’s one of the reasons that puts the U.S. military among the world’s best.

However it’s also a problem when you’re thinking about leaving the service. Your chain of command is concerned about retention, and they’d like to keep you around for a few more years: “How can you find a civilian job in this economy? What makes you think you can hack it in the corporate world? What possible skills do you have that an employer wants?” When we finally leave active duty our own competitive spirit kicks in, along with that little internal drill sergeant: “Do I have what it takes or am I worthless & weak? Am I still relevant? Do I still have a dog in the fight? What do I need to do to succeed in this strange civilian corporate culture?”

Any military veteran knows that the civilian transition can be treacherous, but we bring plenty of skills. We can evolve into great corporate employees and executives. However our competitive spirit, our constant drive for improvement, and our military inferiority complex all make us work at careers we may not particularly enjoy– for far longer than we should. “Heck, the job’s not so bad. Why, compared to this one time in Iraq…”

If you choose to quit the job then it’s even more intimidating: you have to be responsible for your own entertainment. A workplace can form a social structure to provide that stimulation, as well as giving you a reason to get out of bed in the morning. But back in 2006 the creator of Early-Retirement.org used to describe the workplace with an analogy: You go through your working career with one bucket in each hand, labeled “Financial Independence” and “Workplace BS”. Both fill slowly over the years, although you have some influence over their fill rate. When the FI bucket is full, however, something odd happens to the BS bucket. It suddenly fills more rapidly than ever and begins overflowing.

If you’re getting autonomy, complexity, and fulfillment from your workplace then maybe the BS bucket doesn’t overflow. But FI certainly gives you choices. Once you’re financially independent and have no compelling fiscal reason to show up for work, the dissatisfiers quickly become worse. You suddenly can no longer tolerate the rush-hour commute, the workplace uniforms, the meetings, the mandatory training seminars, the boss, some of the co-workers or customers, the business travel, or even the poor timing. When the surfing is good, you want to be able to just go surfing instead of having to rearrange your work schedule.

If you enjoy your work so much that you’re willing to put up with all of those dissatisfiers, then you should keep working. But if the BS bucket is getting too full, then you need to figure out if there’s a way to change the way you work. Maybe you need to shift your schedule to avoid rush hour, or cut back on your hours, or be excused from further meetings, or otherwise re-define your job to your new expectations. If your office claims they “can’t support that” then you could tactfully let them know that it might be time for you to find a new office– or no office at all. When they understand that their choices are “less of you” or “none of you” then they may reluctantly accommodate your desires. If they cannot negotiate then you’re getting a strong signal that your BS bucket will shortly be sloshing over the edge.

You can run the experiment for yourself. See if you can get 30 days off (or a minimum of two weeks). Treat it as a financial independence sabbatical. Instead of cleaning the house and your desk, doing the yardwork, and catching up on your To Do list, treat it as the rest of your life. Spend a day or two getting caught up on sleep, but then put some thought (and spouse discussion) into how you’d spend your day. Get your exercise, do 20 minutes a day of chores, work on a project, spend time with the family, keep adding boxes to your Get-A-Life Tree.

At the end of your time off, take that long commute back to the workplace and see where you stand on your FI & BS buckets.

During the 1990s Intel Corporation used to have a very generous sabbatical program for their more senior employees. A high percentage of them did the same retirement experiment during their time off, and when they returned to work it didn’t take them long to realize what a toxic workplace environment they’d been slowly boiling marinating in. That sabbatical benefit led to at least two early retirees who I know personally, and I think the attrition jeopardized the entire program.

I’m doing it for my kids

Here’s a story that I read on Early-Retirement.org. One of the old-timer members, a military veteran, went on to a successful career and became financially independent in the early 1980s. He decided to stop working, but he was concerned about setting a good example for his teenage daughter so he decided to demonstrate the virtues of work. Each morning he’d get up, shave, dress up in coat & tie, and be at the breakfast table to greet her as she got ready for school. He’d drive off “for work” before she caught the school bus. He’d hang out at the local coffee shop until she was clear, and then he’d return home to change clothes and enjoy his retirement day his way. This continued until she left for college.

Two decades later he confessed this subterfuge to his adult daughter, and she laughed at him. She said that she’d never noticed what he was doing because she was too totally wrapped up in her teenage life (with its drama & angst) to notice what her Dad was doing with his time. She said that even if she’d noticed, she was still too busy with her own drama & angst to care. She never noticed or cared what kind of employment example he was setting. All she really cared about was him being there when she needed him.

Another story: When I retired from the military I told my nine-year-old daughter that I had a job offer. I explained how we already had enough money for the family so that I didn’t need to work, but if I took the job then we’d have even more money. We’d be so rich that we could buy her a horse now and a car for her 16th birthday. She was absolutely thrilled at a “Dad Of The Decade” level. Then I told her that I’d have to be gone every weekday from 7 AM to 5 PM instead of being around when she got home from school. She’d have to get herself up in the mornings, get her own breakfasts, get out the door on her own, come home from school on her own, fix her own snacks, and take care of herself (and her homework) until I got home. I told her that I wouldn’t have midwatches or weekend duty (let alone deployments) but I wouldn’t be able to volunteer to help out at school or chaperone fieldtrips. It took her about 10 seconds to decide that wasn’t worth the privileges of having a horse and a car. She wanted the quality parental time.

Oddly enough, for the next nine years she got herself up in the mornings, got her own breakfasts, got out the door on her own, came home from school on her own, fixed her own snacks, and took care of herself (and her homework). She didn’t need me to do anything for her. She just wanted me to be there for her. Of course from a parental perspective my after-school presence helped her talk through a few drama/angst meltdowns.

She turns 21 years old in a few months, and when I started writing this post I asked her again if she would have rather had my money or my time. She chose “time”, of course, and then went on to say that she thought my retiring so young actually set a better example for her. In her 20-something wisdom, she now has a goal of saving as much as she can so that she’s also financially independent in her 40s.

The only thing your kids want is your time. Younger kids just want to play with you or have the thrill of seeing you in their classrooms and on field trips. Older kids may be a little skeptical that you have enough money to take care of them, but you can explain the family budget and reassure them that their allowance is part of the plan.

Teens would be relieved to see that you’re busting your butt in the workplace to bag the money to achieve financial independence, and then hanging out in your shorts to be successful in the world in your own way. I think they’d rather be judged on fulfilling their own goals than to see us keeping score with dollar bills or worrying how to occupy our time.

My spouse and I see retirement differently

If you and your spouse could handle the military together, I’d hope that the two of you could figure out how to handle retirement together. If you’re working because your spouse isn’t ready for retirement, then the two of you need to communicate and negotiate. Maybe your better half has their own personal struggles with the issues I’ve already mentioned, or maybe they’re concerned about having you underfoot (or in their face) all day long. Maybe you want to do things in retirement that they don’t care for, but does it mean that neither of you can ever retire? Those are perfectly valid issues that need to be acknowledged and then worked through. Retirement can provide a tremendous boost to your relationship– the sooner you have the conversation, the sooner you can reach an agreement.

I’ll leave you with one more thought. On active duty you probably had a set of emergency/casualty procedures that you trained on, held drills on, and critiqued the performance of. No matter what happened or when, you were ready to drop everything and deal with the problem. You should do the same with early retirement for both yourself and your family. The reason is that someday there’s going to be a medical emergency or a family problem. Maybe it’ll be yours personally, or your spouse/kids, or one of your elders. You’ll take leave from the job and deal with the situation. But whatever happens, about 48 hours into that crisis you’re going to find yourself questioning exactly why you’re still going to work when you could be living life on your own terms. Whatever struggles you’re going through will make your own life seem a lot more precious than the corporate routine. You may even be facing weeks or years of potential recuperation, rehab, and caregiving (hopefully not for you but possibly for that loved one). These crises will force you to define and reorganize your priorities.

Your military training and your emergency/casualty procedures got you through the operational crises. Maybe you’ll get through your personal/family crisis just fine, shake off the fallout, and scamper back to the workplace to pick up where you left off. But perhaps you’d have much more time for thoughtful analysis & discussion of this situation if consider it now, just like training & drills, instead of having to go through it when the crisis happens to you.

I think it’s much better to achieve financial independence and have an early-retirement contingency plan rather than to boldly proclaim that you choose to work for the rest of your life. It’s all about giving yourself choices, and being ready for your own personal growth & change.

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Filed Under: "What do you DO all day?!?" · Tagged With: early retirement, financial independence, military, military retirement

More problems with peer-to-peer lending

June 6, 2013 by Doug Nordman · 6 Comments

[The first post of this series described the general concepts and issues with peer-to-peer lending and the borrowing process. If you're coming here from a search engine then you should read that first post and the P2P borrowing calculator post before you read any more of this one. Understand the companies and the borrowers you'll be dealing with.]

It’s the new hot way to make money. It’s really different this time. The Internet makes everything better. All the cool kids are doing it. Don’t get left behind. You know you want to be part of the peer-to-peer lending group, too!

Hmm, maybe not so fast. The last two posts explained why P2P loans can be a bad idea for borrowers, but lenders might have it even worse. The individual investors and venture capitalists who funded P2P lending companies have certainly earned whatever their shares might be worth someday, and the employees of the P2P lending business have created an innovative model with impressive websites that are starting to scale. Some of them have even managed to generate revenues with it.

I’ve done a lot of P2P reading in the last few months, and it seems as if every person who’s written about P2P lending has made some money at it. A few have made quite a bit of money at it. One or two may be able to retire early and live the rest of their lives from this income stream. I should also point out that nobody seems to be blogging about “I lost a fortune on P2P lending”, although you can find some entertaining articles by searching on the phrase “P2P lending sucks”. Of course P2P’s survivor bias suits my personal confirmation bias, and I’m experienced enough (or at least old enough) to recognize that as a danger signal.

Don’t link your checking account to a P2P lender just yet. The end of this post will point you to some excellent bloggers who can show you how to do that, but first let me share what I’ve learned.

The P2P business sector

Before we talk about the P2P lending companies, let’s put their business into perspective.

This FDIC statistical summary says that in the first quarter of 2013 there were 7019 FDIC-insured banks, down nearly 300 banks from 2012. During the last year, the surviving banks made new loans that amounted to $248 billion.

During the entire tenure of America’s two biggest P2P lenders, Lending Club and Prosper, all of the loans that they’ve facilitated amount to just over $2.3 billion. It took both businesses over five years to lend out that much money, and it’s still less than one percent of the money loaned by the entire banking industry in just one year. Although Lending Club and Prosper have come up with a creative and disruptive business model, they’re barely an asterisk in the national database. If both companies manage to grow by 100% over the next year then they’ll still have less than one-half of one percent of the American loan market. If they double again in 2015 then they’ll still be a “<1%” footnote on that PDF.

I don’t think that the executives of Wells Fargo and Bank of America are laying awake at night worrying about the next moves of the P2P industry. If either group of execs really cared, they wouldn’t even try to compete. They’d just set aside a few days of their cash flow to buy the two biggest P2P companies. If you’re lending money through a P2P company, how would you feel when you read the headlines about their acquisition by a corporate monolith like BofA?

The American P2P companies

Prosper Marketplace Inc. actually took an early lead in the sector by starting operations in 2006, followed by LendingClub Corporation (yeah, that’s one word) a little over a year later. Both companies had to “pause” in 2008 to register their lending activities with the SEC, but both have grown steadily since then. It’s worth noting that both companies survived the Great Recession, an accomplishment failed by a significant number of extinct banks on that FDIC statistical summary. Both P2P lenders also survived without taking a dime of government money.

[Let me add a quick note about the links in this post. The information in that last paragraph was taken from the latest Lending Club prospectus and from the latest Prosper prospectus. (Both of those links will open PDF files.) I'll include more links throughout this post, but if I don't specifically link a statement then it's from one of these two documents. However both P2P company's websites and blogs and some SEC filings are updated more often than the prospectus, so please let me know if you find a conflict. I'll do more research and update the info from the current source.]

Each one of those PDFs is over 120 pages long, and they’re written in typical turgid accounting prose. You don’t have to be a CFP or a CPA to comprehend the text, but it helps to understand a little about accounting and about how companies operate. I’ve read through both documents several times, and I think I understand the contents, but I’m not an investment professional. You have to make the time and the effort to read at least these two documents, or else you should not be acting as a lender with either company. You have to understand the risks you’re taking or you’ll get surprised by something that’s already part of the company’s rules.

If you feel that you know enough about the business “just” from reading some of the excellent blogs on P2P lending then you’re gambling & hoping– not investing.

Lending Club is so much bigger than Prosper (in terms of loan volume), and Prosper is so much bigger than the third-largest P2P lender, that I’m only going to talk about these two companies. There are smaller American P2P lenders, and there are several overseas P2P lenders, but Lending Club and Prosper are effectively the American P2P lending market. Keep in mind that even though these two are the “giants” of P2P lending, they’re still a very small part of the lending industry.

Lending Club overview

Lending Club’s latest 10K SEC filing describes a fairly encouraging status for a startup company. During six years of operations they’ve raised $102.5M through several rounds. A 2012 funding round valued Lending Club at over $500M, so they’re making great progress through the startup minefield. They lost over $4 million from March-December 2012 but the last three months of that showed positive cashflow from operations. The technical terms in that last sentence mean that Lending Club took in more money than they spent (and they made employee payroll) but the company is still not profitable. However they’re headed in the right direction, with both rising loan volume and rising revenue. April was Lending Club’s best month ever, with over $140M in loans. They issued $780M in loans in 2012 and expect to reach $2B in 2013, so that 100% growth target looks “reasonable” and is certainly achievable.

Tech investors love it. Last month Google and Foundation Capital purchased $125M of shares at a price which values Lending Club at over $1.5B– a tripling of value in less than a year. The money was paid to existing shareholders (who sold some or all of their shares), not to Lending Club, and it gave Google an observer seat on the company’s board. A Google exec will be joining a group that already includes Mary Meeker, John Mack, and Larry Summers. Lending Club might even file for an initial public offering during 2014, although that’s strictly a rumor.

Enough of the good news: Lending Club is also a victim of its own success. The real reason that they loaned out $140M last month is because they screwed up– they couldn’t approve the applications fast enough to lend out even more. They’re just not scaling fast enough yet.

Their standards mean that they approve fewer than 10% of their “quality borrower” applications, and existing lenders are snatching up the available applications even before Lending Club has finished verifying them. (This is despite the fact that Lending Club only checks the borrower’s credit score and credit report. They verify the income statements on just 60% of their applications– they don’t even try to verify all stated income.) There are so few approved borrowers relative to lenders that the lenders have to manually click on the loans at specific times of the day before they’re gone– Lending Club hasn’t even fully implemented an automated tool yet. Lending Club actually admits that they’re “prudently reducing their investor acquisition efforts”… because they can’t keep up.

The weak link in Lending Club’s approval process is that they need too many employees. As of the end of 2012 they had 89 people working in sales, marketing, & customer service. This includes their employees in collections, credit, operations and “member support”. However Lending Club customer (and Forbes blogger) Marc Prosser has noted that even if each employee could make a decision on an application within 30 minutes, LC would still need over 150 people just to review January’s borrower volume.

Yeah, I know, it’s good to have growth problems. But when your money is sitting in a holding account instead of being loaned out to a “qualified” borrower, your ROI is zero.

Prosper overview

Compared to Lending Club, Prosper seems lucky to be in business. Their first-mover advantage turned out to work against them, and as pointed out by Peter Renton’s LendAcademy.com they’re practically rebooting the whole operation this year.

In early 2012 it looked like Prosper had raised about $40M in funding. As near as I can tell from the balance sheet in their 2012 10K, by the end of that year Prosper had raised about $83M and burned through nearly all of it. In early 2013 they raised an additional $20M which their 2012 10K describes as a “recapitalization” (always a touchy word for a startup finance company) led by Sequoia Capital and their existing shareholders.

As part of that funding, the new investors cleaned house. Prosper’s new CEO, Stephan Vermut, is part of the new team of execs and board members. The old CEO and a founder have left the company. A couple of months ago Prosper’s new President, Aaron Vermut, also joined the company. (Yes, he’s the CEO’s son, as previously noted on LendAcademy.) The new board members might not have the name recognition of Lending Club, but they’re all professional financial managers and experienced venture capitalists with experience and access to help. While a father-son team may seem a little odd, they’ve worked together before at a previous company for several years. It looks like Sequoia was only willing to invest if Stephan Vermut was available to take the reins, and his team has already built a successful company before coming to Prosper.

The turnaround is in progress. Prosper has been reworking the company structure to offer more protection to lenders and implemented a new API to make the borrower data more accessible. April was their biggest loan volume ever, and up nearly 75% from a year ago. The loan volume is particularly impressive in this chart at the end of this LendAcademy.com post showing Prosper’s stumbles in the last quarter of 2012 and their turnaround in the first quarter of 2013. However the Lending Club chart in the same blog post shows that Prosper has a long competitive slog ahead of them.

Unfortunately Prosper’s new team inherited some old legal baggage for this new era. Prosper has been litigating a class-action lawsuit since late 2008. Their earliest lenders allege that the company’s initial business model violated a number of state and federal security laws. What the plaintiffs really want, however, is damages to help replace the capital they lost. Nearly 20% of the loans from Prosper’s early days were delinquent, and nearly a third of the loans from one particularly bad month were delinquent. Prosper has already charged off most of these loans but the lawsuit may require the company to pay additional capital to the plaintiffs. I can’t find any more credible information on the progress of the lawsuit, but the new team of execs know that it’s in their best interests to settle this one quickly. Prosper has already successfully staved off a potential brush with bankruptcy, and I think they’ll minimize the lawsuit liability as well. With their rising loan volume and their improved management, they may even be able to afford to pay for it out of revenues.

Now that I’ve laid out the differences between the two companies, I’ll describe their similarities.

P2P company lending process

Not only do the P2P companies have similar lending processes, but they both use Wells Fargo and the online bank WebBank. Prosper and Lending Club act as loan processors, moving your money between accounts to fund the loans and collect the payments.

When a borrower files an application on either P2P company’s website, their FICO score and credit report are checked. Once the company is satisfied that the borrower meets their minimum criteria and has a valid ID, the application is posted for lenders to purchase.

When a lender links their checking account to a P2P company, their funds go to an escrow account held with Wells Fargo. The escrow accounts are FDIC-insured up to $250K for each individual, so your money is still safe before you lend it out. Although the account might be earning interest, you don’t get any of it. Your money sits there, losing to inflation, as long as it takes you (or the P2P company) to put it to work on a loan.

A typical lender will diversify their assets by only “buying” $25-$50 of each loan. Applications from high-quality borrowers may be funded in a matter of minutes, but some low-quality borrowers are also attractive. (Aggressive lenders think that low-quality borrowers will pay a disproportionately high interest rate with an acceptable percentage of defaults.) In addition to individual lenders (the “peers” of P2P), some financial institutions invest their corporate funds through a P2P company. Prosper and Lending Club will also automatically invest the (larger) accounts of qualified individual lenders. The theory is that every lender, individual or corporate, has the same opportunity to fund a loan. However the P2P companies may make selected “entire loans” available to institutions or accredited investors, while other loans may be funded through automated programs. The P2P companies claim to make roughly the same percentages of all loans available to all of their customers, and you’ll have to trust them on that.

If you’re an individual investor with a Lending Club account, it may also mean that you’ll be lurking their website at 6AM, 10AM, 2PM, and 6PM Pacific Time hoping to beat out your fellow “peers” for the loans that meet your criteria.

At some point a borrower’s loan has enough demand to be funded. When that happens, the P2P companies deduct the money from the lender’s accounts send it (minus the P2P company’s fee) to WebBank. WebBank actually sends the money to the borrower in exchange for the borrower’s promissory note. WebBank then assigns the non-recourse promissory note back to the P2P lender, who uses it to distribute principal & interest payments to lender accounts (minus the P2P company’s fee).

Although this promissory-note process seems cumbersome, it meets the SEC’s requirements to track the funds and to protect investors. Here’s a block diagram for Lending Club from their prospectus:

A diagram of how borrowers and lenders use Lending Club to process loans

Lending Club loan diagram

There’s a similar diagram on page 14 of Prosper’s prospectus.

Lender commitment: 3-5 years

The non-recourse promissory note stays with the P2P company, not the lender. This is a good thing. The P2P companies earn their revenues from the fees on servicing the loans, but they can also charge additional fees to borrowers. If the borrower stops making payments then the P2P companies hold the legal paperwork to start the delinquency and collection process.

If a borrower is late on their payments, the P2P companies charge late fees. Late fees (minus the P2P company’s fee) go to lenders, but this is still a sign if impending trouble. If a loan defaults (usually more than 120 days late) then the P2P companies charge additional collection fees. However the lenders don’t get any of these extra revenues, and they’re losing interest while hoping that the borrower will bring the loan current. If the borrower declares bankruptcy then the lender gets nothing.

At this point, a lender has committed their money for a minimum of three years. If the borrower makes their payments on time then the lender receives a stream of income, and they can withdraw that income at any time. (Most lenders re-invest in more loans.) If the loan is paid back on schedule then the lender has received their principal & interest. If the loan is paid early (which seems to be rare) then lenders get less interest. However if any payments are late then the loan may revert to a five-year note. If the borrower defaults then lenders lose some principal and interest. These are unsecured loans so there’s no collateral for lenders to seize.

So how many loans go into default? That’s a difficult question, and it doesn’t have a credible answer. The riskier the loan, the higher the interest rate, but the higher the chance of default. The current lending programs have only been in effect for about five years, and that’s not enough history to make a valid statistical prediction. In addition, the P2P companies keep improving their criteria so it’s difficult to compare loans across the years and programs. Overall, only 2%-3% of the loans have defaulted. However Lending Club assumes that at least 5% of their riskiest loans will default, and Prosper assumes that over 15% of their riskiest loans will default. Yet Prosper also had a very bad month in 2007 when over 30% of their loans defaulted.

Another problem with the default statistics is that both lenders are making up the metrics as they go along. (Hey, they’re creating the business model, so they get to choose most of the parameters.) Lender’s returns are projected into the future with assumed default rates, not the actual ROI. Loans aren’t formally written off until long after the borrowers have stopped paying. If a three-year loan becomes a five-year loan, now two statistics databases have to be updated. Lenders don’t have easy access to the real-time performance data, let alone the rights to audit the results. The whole system is ripe for data-mining and cherry-picking, even before the marketing committee puts together their campaign.

As equity investors know all too well, history is next to useless at predicting the future. Both Prosper and Lending Club were just getting started when the 2008 financial crisis hit, and they were “paused” by SEC injunction for much of that time. Nobody knows how borrowers will behave next year, or during the next recession, or whenever interest rates start rising again.

“Unsecured” also means that the lender has a low-priority claim on collection efforts. If the borrower declares bankruptcy then the lender gets nothing more. If the borrower dies then the estate executor has the discretion to pay the loan– or not. It’s the executor’s decision, not the lender’s.

Can lenders get their money back before the loan is paid off? Sort of. Both Prosper & Lending Club use FOLIOfn to provide a secondary market for trading the promissory notes. However the notes in the secondary market are heavily discounted because most of them are delinquent. Other lenders can buy new notes from the P2P companies, so lenders on the secondary market will only buy your note at a discount. Selling your loan here means that you’ll wipe out your profits and even some of your principal.

One more time: lenders have to commit their principal for 3-5 years in exchange for monthly payments. Liquidity is very limited. Although lenders can sell their notes on a secondary exchange, the discounted price will almost certainly result in loss of interest & principal.

P2P company bankruptcy

Another reason for this complicated lending process is a legal protection that nobody wants to talk about: bankruptcy. The P2P companies will survive only if they eventually earn more in fees than they spend in processing the loans (or collecting on them). After more than five years of effort, and ~$200M in expenses between them, only Lending Club has succeeded in this goal– and only for the last three months of 2012. Prosper actually came within a few months of going bankrupt. Eventually the investors are going to stop coughing up the cash and expect these two companies to execute on their business models– or the investors will pull the plug and start fighting over the carcasses.

If either P2P company goes bankrupt, then what happens to the lenders and the borrowers?

Both Lending Club and Prosper hold the notes in trust for their lenders, much like stockbrokers and mutual fund companies hold shares for their customers. Each P2P company has contracted with a backup to take over the loan processing during their bankruptcy. This is an accepted practice in the financial industry, and it happens more often than you might expect. However it does not happen instantly or flawlessly. There will inevitably be computer glitches, customer service lapses, disgruntled (unpaid) employees, regulatory interference, media hype, and uncertainty.

Borrowers might be tempted to stop paying money to a bankrupt company, but they’d be wise to continue paying their loans right on time. They signed a non-recourse promissory note, and the holder of that note can come after them with the full force of the law. However if there’s enough chaos (or if the backup customer service screws up their payments) then borrowers might just walk away.

How many borrowers will default if a P2P company goes bankrupt? Nobody knows. There’s just not enough history to make an intelligent guess.

Lenders should continue to receive their principal and interest payments from the borrowers, as soon as the backup processing company has taken control. Both P2P companies have done their best to make sure that their bankruptcies would go through the courts without their legal issues affecting the promissory notes. (Good luck with that.) However the lenders are a mix of financial institutions, accredited investors, qualified investors, and retail investors. Nobody knows whether the notes would continue to pay out per each lender’s share, or whether some lenders would claim a higher priority. Institutional lenders have the assets (and the legal expertise) to perturb this process for months. I’m not sure who’d stick up for the retail investors… certainly not the FDIC or the SEC.

How long will it take for lenders to receive whatever funds they have on deposit with the loan processor? Nobody knows. It’ll be a minimum of the remaining term of the loan, unless the bankruptcy is tied up in the courts for longer. If borrowers default en masse then it’ll be a lot quicker, but nobody wants that type of answer.

Should you invest through Prosper, given their shaky finances and their legal issues? The only reason to do so would be if you feel that you can boost your returns with their riskiest loans. Those loans (at APRs as high as 35%) will almost certainly have a higher default rate, which means that lenders will have to be especially vigilant about selection and diversification. I’m not sure that the additional return is worth the very real default risk and the huge additional lender labor to screen the loans. Everybody loves an underdog, but Prosper is very thinly capitalized and still has the legal liability hanging over their financial future.

P2P lending company execution

I hope the last 4000 words have given you a perspective of how difficult it can be to execute an innovative idea with a good business plan. Lending Club and Prosper didn’t just have to break the old rules– they had to write the new rule books and defend them to the regulatory authorities and their investors. As horrific as their finances might seem today, they’re among the top 1% of startup companies.

However the survival skills that got them here are irrelevant to their futures. Founders of successful companies are great at getting them to revenue, but they mostly suck at the only metric that counts from now on: growth. Both companies have to add as many borrowers as quickly as possible, and as cheaply as possible, without buying more infrastructure. They’re already spending millions of dollars on marketing and other “customer acquisition” costs, and now they have to figure out how to scale that effort along with their lending software.

Prosper has limped along for years of uneven performance, but today they might actually have a better executive team climbing the growth curve. The “new guys” have considerable Wall Street and banking experience, have already built at least one successful business, and are presumably ready to do it again. Hopefully there aren’t too many surprises lurking from the founder’s era.

Lending Club is already discovering the limits of their system. Their software is too slow, or it requires too much human intervention to approve borrowers, or it’s too hard for the lender users to automate. Maybe it doesn’t scale from 10,000 lenders to 10 million. Maybe they can tweak it, or more realistically (like Facebook) they’ll have to scrap it and rewrite it.

In the meantime I’d hate to be a worker-bee in either cubicle farm. Management is surely squeezing the staff to move as fast as possible with as little as possible. It’s all too easy to start cutting corners on the borrower applications. It’s all too tempting for the risk committees to change interest rates to please their customers instead of to adequately compensate for the risk. It’s all too expedient for the statistics & probabilities (what few there are) to get trampled in the rush to move more money out the door. Anyone who raises a caution flag, let alone tries to hit the emergency button on the assembly line, will receive way too much of the wrong kind of supervisory attention. I’m sure that their talent can command a high price in their area, and the compensation metrics might not necessarily be aligned with the best interests of the lenders.

Even without the temptations of fraud & theft, good people will end up taking risks that they don’t truly comprehend. I wonder how much they learned from the 2008 mortgage-lending crisis.

Loan default rates could double during 2013 just from these execution issues.

Your weaknesses as a lender

Unless you’ve worked in the loan business, then I’m pretty sure you also suck at figuring out whether an anonymous borrower is likely to pay back your loan.

Both P2P companies try to avoid outright borrower fraud, but let’s face it: they make their money from moving more borrowers faster with more money. It’s up to you to choose the right borrowers, and you have no idea what you’re doing.

“Luckily” both Lending Club and Prosper recommend that you “diversify” by doling out a little money to each of a lot of different borrowers. The statistics start to work in your favor when you rise above 400 loans. (Every Lending Club lender with at least 800 loans has made money– so far.) Are some borrowers more likely to pay than others? Sure, that’s pretty easy to figure out from credit scores alone. However you can’t tell whether borrowers are stating the truth about a lot of other parameters. You certainly can’t tell whether the interest rate they’re promising to pay is adequately compensating you for the (unknown) risk that you’re taking.

I don’t know about you, but this situation would paralyze me with indecision.

Unfortunately Lending Club and Prosper have been thinking about this customer acquisition paralysis issue for a lot longer than we lenders have.

“Illusion of control”
Their marketing solution is to give you the illusion of control. You’re fooled into thinking that your hard work pays off.

Each company’s website lets you look at every loan– right down to the borrower’s personal appeal reason for borrowing your money. Each website has a plethora of screening tools to help you choose the perfect borrower. It has everything except levers, switches, knobs, and flashing lights. If you don’t feel comfortable screening on your own then there are dozens of blogs and third-party tools to crunch the existing data, backtest it, and extrapolate it. You have tremendous control in choosing where you put your money, and there are many powerful tools for analyzing the loan portfolio. The only problem is that nobody really has enough data to know whether any of it works.

But that thinking shouldn’t distract you from the fascinating tools: Excel spreadsheets, pivot tables, backtesting algorithms, proprietary screening tools, lender discussion forums, and borrower’s personal statements. You could spend hours tweaking each of the parameters and never have to consider whether you’re working with gold– or garbage.

I should point out that personal-finance bloggers (and nuclear engineers) are especially susceptible to this weakness. We’re all about the control, and our hard work is the critical factor behind accelerating our wealth.

“It’s not luck, it’s skill!”
Every existing P2P lender would respond to that last paragraph with “Yeah, but my model works better.” How do you know whether your screening tools are skill or luck? One possibility is that you’re a brilliant loan analyst. Another is that you’ve built a diversified portfolio which happened to weather the last storm of defaults. A final possibility is that you’re just freakin’ lucky. How much data does it take to know which possibility applies to you?

Jason Hull has already crunched some of those numbers, and the short answer is “for the riskiest loans, over $18,000 and 3-5 years”. For the high-quality loans (with a lot more borrowers) the number is more like $180,000. If you just want to know whether you’ll break even, then the answer is only about $2750– but you’ll still have to wait until all the loans are paid back (or defaulted). Those Lending Club members with their 800 loans who have all made money? At $25 per loan, each of them has committed at least $20,000 for 3-5 years. Each of these companies has only been lending money through their current process for five years. Where will they be in another 3-5 years?

“An exclusive club for very special members.”
We all want to belong to a place that appreciates us, but we’re not just anybody. Both companies warn their potential lenders that their services may not be available in your state. Both warn that you need to be “qualified investors” who are presumably smart educated enough to understand the rules and the risks. Both have extensive disclaimers and risk disclosures and a whole highway filled with signs claiming “Danger– excitement ahead!!” It’s almost as if they can tell that you have money.

Oh, and you can get a discount with access to special tools, too. What’s not to like?

“I’m doing this with my friends. All five million of them.”
Another marketing issue is the social proof aspect of peer-to-peer lending. (Note that the author of that linked article is a partner at one of Silicon Valley’s biggest and most successful VC firms.) It’s so high school, but it works so well. You’re not only one of the cool kids again– you’re helping people just like you overcome their debt problems. Better yet, you’re doing it with an awesome team of lenders who are also coincidentally just as charming, analytical, and successful as you. We’re all brilliant investors, too!

“Chasing yield”
Whether we’re brilliant or not, there’s still those righteous double-digit returns. If some of your asset allocation is in bonds, or more of your money is sitting in a low-yield savings account, then how can we pass up P2P lending?!?

Chasing yield is a major behavioral psychology problem. Those assets are in your portfolio to lower its volatility and to help you ride out a bear market. If you’re a value investor then your cash is sitting idle (losing to inflation) for several years while you wait for an asset dollar to go on sale for 75 cents. The advantages of your low-yield bonds and your spare cash are lower overall volatility and the liquidity to quickly buy a bargain when it goes on sale. You get a big discount for paying cash, but until the next recession surprises us then you can’t tell whether you’re the next Warren Buffett… or just another hypercautious idiot.

If you’re saving up a down payment to buy a home in five years, but it’s only earning 0.6% in a money-market account… hey, don’t even go there.

“It’s not that hard, and they’ll do it for you.”
P2P lending is too much work, especially if you’re deployed to the desert. Not only is P2P too much effort, but you’re slaving away (admittedly on a great website with fascinating tools) at minimum wage. Just like gambling, it’s mostly entertainment: the more work you put into it, the less money you’ll lose. You might even make money, but you’d make far more money by (as Jason writes) investing in yourself.

Lending Club has a PRIME program that automates much of your effort. For a minimum portfolio of $25,000 (and an additional 0.8% fee) you’ll choose a risk level and they’ll do the rest. Even before Lending Club’s latest loan-processing challenges, it took nearly three months for PRIME to invest one (very experienced) lender’s $52K. Prosper attempts a similar automation with their “Quick Invest” tool. However these helpful conveniences just make it even easier for you to hand over your money without doing any due diligence on the compensation you’re receiving for the risk you’re taking. More brilliant marketing by both Lending Club and Prosper.

“But we can afford it!”
There’s another aspect of P2P lending for my older readers (especially military retirees). If you’re barely surviving your retirement budget on your pension & savings then P2P losses (like a Prosper bankruptcy with accounts frozen for three months) can destroy your portfolio. But many military retirees (especially dual-military couples) have found that they have more assets than they need. When that happens, you stop hustling for a buck and only do things that bring you fulfillment without sacrificing your autonomy. At a minimum you (*ahem*) do more surfing & traveling. Otherwise you spend time on enjoyable projects where you feel your efforts will be more rewarded, like writing & philanthropy. If you can afford to lose the money then P2P lending becomes just another speculative asset class without a track record. It’s just as much an entertainment expense as a part of a diversified investment portfolio.

“But what if we…”
I’ve written nearly 13,000 words over three posts on this subject, and the investor psychology still almost sucked me in. I’ve tremendously enjoyed this research project (and the challenge of explaining it), and nearly every aspect of P2P lending plays to my financial vulnerabilities. Every day when I read or wrote, I was looking for the secret that would give me an incentive to sign up. I have to admit that I’m still a nuke– I’m still tempted to “give it a try” and “do it right”. Surely it’ll be different this time!

Luckily, I’ve been investing long enough to recognize the addictive signs and to know my weaknesses. Over the years I’ve turned into a lazy highly efficient investor, and I don’t feel that P2P’s results will help me distinguish luck from effort. It would become yet another project in an already busy life.

Minimize your risk

So after this ringing three-post endorsement, why would any investor in their right mind even consider peer-to-peer lending?

Oh, yeah, the chance to get in on the ground second floor and chase double-digit yields– before all the good deals are gone.

Not that any of us brilliant investors would be swayed by that type of P2P behavioral psychology marketing.

I hope I’ve shown that you can’t quantify the risk– and you don’t know whether you’re being paid enough to take the risk. Even the companies might not stay in business. Everything else is marketing & sales pressure playing to your psychological vulnerabilities.

If P2P lending is important to you, then treat it like any other single-asset allocation risk. I’d urge you to put no more than 10% of your investment portfolio into the entire sector– and kiss it goodbye for at least 3-5 years! I’d suggest that you split it between Prosper and Lending Club, so that one bankruptcy won’t (temporarily) freeze all your P2P assets.

I strongly recommend that all prospective lenders read the risk factors on Lending Club’s prospectus and on Prosper’s prospectus. Both of those disclosures start on page 13 of the PDFs. (If your culture ascribes bad luck to the number 13, then… eh, I’m sure that’s just a formatting coincidence.) Don’t trust the fancy graphics & charts on the P2P company’s websites. Read the legal documents. If you don’t understand something in those risk factors then please ask your financial advisor or post a comment– we’ll figure it out for you.

If you have TL;DR syndrome and can’t be bothered to read a prospectus, then don’t engage in P2P lending. You’ll be much happier at a gambling casino, and the drinks might even be free.

Here are a few websites with more details on executing a P2P lending plan:
Peter Renton’s Lend Academy. Peter’s the leader in the field, with many contacts at both companies. He’s also built up a six-figure portfolio for both himself and a relative.
MrMoneyMustache’s Lending Club experiment. He’s using the money generated by his blog’s revenue.
Military Money Manual Lending Club report. He’s done it even while deployed to a combat zone.
Mike at Live The New Economy. He’s exploring both Lending Club and Prosper.
Rob Aeschbach on two types of risks with P2P lending

Thanks to poster “Footenote” on Mr. Money Mustache for the Economist article “Crowdfunding in America: End of the peer show”!

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Filed Under: Finances · Tagged With: early retirement, financial independence, military, military retirement, P2P, peer-to-peer lending

Peer-to-peer loan calculator

June 3, 2013 by Doug Nordman · 1 Comment

[The last post described the general concepts and issues with peer-to-peer lending. If you're coming here from a search engine then you should read that post before you start plugging numbers into the calculator. You may decide that there's a better way to pay off debts than a peer-to-peer loan.]

Welcome to the peer-to-peer loan calculator!

This blog doesn’t talk about debt very much. If you’re pushing hard to reach financial independence then you probably left debt in the dust long ago and you’re saving at least 20% of your income. However this post is part of a series on P2P lending, and about the only reason that people become P2P borrowers is when they don’t have enough money. Maybe they were ambushed by a large expense (with perhaps a high interest rate), or maybe they’ve spent more than they earned.

How deep can you dig?

If you’re thinking about borrowing money from a P2P lender then you’ve already decided that this is your best choice of a very limited range of financing options. If you’re considering lending money through a P2P company then this is your chance to see how your prospective borrowers are thinking.

Before we go any further, let’s figure out whether you’re wasting your time with these lenders. Here’s what Lending Club wants to see from you:

a minimum FICO score of 660;
a debt-to-income ratio (excluding mortgage) below 35%, as calculated by
- the debt reported by a consumer reporting agency; and
- the income reported by the borrower;
a minimum credit history of 36 months with
- less than seven inquiries in the last six months, and
- at least two current revolving trade accounts.

In other words you need to have at least a 660 credit score. Your current debt-to-income ratio can’t exceed 35%, but Lending Club will excuse your mortgage from that ratio. You also have to have at least three years of credit history (with other loans or credit cards). That has to include at least two accounts that are current (not delinquent) and your credit report can’t have more than six other inquiries on it. If you’ve been late on your credit card payments, or if you’ve applied for a bunch of other loans, then you may be out of luck with Lending Club for a few months.

No Lending Club? No problem! Here’s what the Prosper prospectus expects:

a minimum FICO score of 640, except for Prosper second-time borrowers who may have a score as low as 600.

Um, that’s it for Prosper. The company is seeking a much wider variety of customers, but Prosper’s riskiest loans will charge very high interest rates. There are very few minimums for the Prosper application but your credit report and your debt-to-income ratio can still reduce your qualification score (and raise your loan’s interest rate). Prosper is not flinging buckets of money at its borrowers– they’re simply expecting their lenders to do their own due diligence.

Note that both P2P lender websites will expect to see some income. In other words, you should have a job. (If you have enough income from other assets to afford to make P2P loan payments, then perhaps you’d just cash in those other assets and pay off the credit card without the P2P loan.) Your interest rate will be set by the debt-to-income ratio that’s calculated from your salary, so you’re going to earn your way out of this debt problem.

Lending Club and Prosper do minimal diligence on your application. It’s more than a credit-card application or a payday-loan company, but it’s far less than a bank loan. The P2P lenders will verify your identity and do a credit check, but that’s about all they can afford. Neither of these companies is profitable, and only Lending Club has had a quarter where revenues exceeded expenses.

This means that both companies base much of their screening on the information you provide. They could ask for verification, but that costs time & money. They may have a few “lie detector” software tools to help them review your application, but they’re largely depending on you to tell the truth. You could be tempted to pad your “stated income” with a little anticipated overtime (or the revenue you expect to earn from your blog), but don’t even start down that road. Tell the truth and don’t enhance your profile. (If you lie on the application, that’s considered “fraud”.) Their screening process may only give you one shot at your loan and no flexibility on your interest rate. Answer questions as promptly as you can and don’t even quibble with the truth. Remember why you’re applying for a P2P loan: because you’ve decided that you’re nearly out of alternatives.

You’re almost ready to start tinkering with the calculator.

P2P lending is an evolving business, and the two major U.S. companies are constantly tinkering with their models. The information that you’re plugging into the calculator comes from their prospectus and their websites, but the two sources may occasionally vary from each other. (I’ve had to go from their websites to their prospectus to their blogs to confirm some details.) If you spot an error in this post, please point me to the new information and I’ll update my links.

The calculator will let you enter any numbers you want, but here’s what you can get from the two P2P companies:

Lending Club:

$1000-$35,000
36-60 payments (Loans from $1,000 – $15,975 are limited to 36 payments.)
APRs from 7%-27%

Prosper:

$2000-$35,000
36-60 payments
APRs from 7%-35%

Note that your loan interest is expressed in terms of APR, not “interest rate”. Part of the reason is that the companies charge an origination fee which is subtracted from the loan amount before they even give you the money. Although you borrowed an amount at a certain interest rate, you’re repaying a smaller amount for longer than one year. The equivalent annual interest rate that you’re paying is required by law to be expressed as the APR so that you can compare one loan’s APR directly to another.

This P2P loan calculator will give you an estimate of your loan payment. It helps you decide whether you should try to pay (1) a higher monthly amount for a shorter-term loan at a lower interest rate rather than (2)a lower monthly amount for years at a higher interest rate. Once you see how these payments affect your budget, you may decide that you can’t afford a P2P loan. Because of the origination fee and the APR, this calculator may produce slightly different numbers than Lending Club or Prosper. If the monthly payments are within $10 then you’re probably fine. If the monthly payments are different by more than $10 then check your loan amount, interest rate, origination fee, and APR.

Let’s walk the calculator through an example.

Assume that you’re paying 27% interest on your $10,000 credit-card debt. I chose that number because a 27% APR works out to about 2% monthly interest on that $10K, which means that it’ll cost you just over $201/month to tread water. (American Express also tells me that if I’m a day late on a payment, they’re going to jack me right up to that APR.) Even if you cut up your credit card (no more charging it!) and can afford to pay $300/month toward that $10K balance, it’ll still take you years to pay it off. Most of your $300/month payment is eaten up by the interest.

What if you can get $10K for three years from a P2P lender at 20%? According to the Lending Club and Prosper websites, that’s a lower APR for a higher-quality borrower. You’d only have to endure the payoff pain for 36 months and you’d pay less interest. But could you afford the higher monthly payments to apply for a P2P loan?

Scroll down to the calculator and enter the following data:

“Loan Amount” as $10,000.00
“Down Payment” is 0
“APR” is 20
“Number of monthly payments” is 36.

Loading Financial Calculator...

Want a different personal loan calc? has many choices

Your calculated new monthly payment is $371.64. However you remember from reading the last post that the P2P lenders are going to deduct 1%-5% of the loan amount when they fund it, so you’re going to start out by borrowing just $9500-$9900. If you re-enter the data into the calculator assuming that the 5% fee leaves you with a $9500.00 loan amount, your payment drops to $353.05. Unfortunately you’ll still have to cough up another $500 of your own money over the next 36 months to finish paying off that credit-card balance at a 27% APR, so that’s roughly another $14.25/month out of your pocket. $353.05 + $14.25 is still $367.30, not too far from the original $371.04 payment.

If you decide to completely pay off your credit card balance by borrowing $10,526, then even at a 5% origination fee you’ll at least have $10K left to send to the card company. In other words, you just paid over $500 to a P2P company to let them “award” you a lower interest rate. You can re-enter that $10,526.00 number into the calculator to determine that your monthly P2P payment will be $391.18. Oh, and now you’re deeper in debt because you borrowed an extra $526.

Let’s take a look at your budget. You had to pay $201/month just to breathe air on your credit-card APR of 27%. If you were paying $300/month then you’d pay it off years later, and that payment might still fit into your budget. Could your budget still survive if you had to pay nearly $400/month? Sure, your APR dropped from the card company’s 27% to the P2P company’s 20%, but you had to squeeze the repayment into 36 months (instead of years). Are you sure you can you handle $400/month?

What if the interest on your $10K credit-card debt was “only” at 13%, and you could borrow the P2P money at “just” 7%? A 13% APR works out to about 1% per month, so your monthly interest payment to the credit-card company would be $102.

Scroll back up to the calculator:

“Loan Amount” as $10,000.00
“Down Payment” is 0
“APR” is 7
“Number of monthly payments” is 36.

This time your monthly payment on a $10K loan amount is “only” $308.77. Once again you’re paying more than your credit-card company is asking for because you’re paying off the loan in just 36 months, not several more years. You’re also paying the P2P company a 1%-5% fee for the privilege.

This is a hard choice. (Probably because both alternatives suck.) By lowering your interest rate, you pay a lower total amount. However by shortening the length of the loan, you pay a higher monthly payment. That’s no problem if you have the room in your budget, but if you have to cut back other spending to pay your P2P loan then you may be putting your finances under even more stress.

Let’s step back from the lending mechanics and the debt payment calculators for a few paragraphs. Take your hands off the P2P website’s fascinating buttons & levers and think about the big picture.

Remember from the last post that you also have to change your spending behavior. Not only do you have to pay off that higher P2P monthly loan amount, but you also have to quit spending more money than you earn and begin a new life of financial responsibility. We’re not just talking about cutting out your daily Starbucks run. This will require no more use of your credit cards, no more fantasy vacations (for up to three years), no new outfits (unless you’re at a thrift store), and maybe even eating out just once or twice a month. The “good” news is that with a P2P loan you only have to put up with your new lifestyle for three years. The “other” news is that you had to pay The Man the P2P company a fee to even get you started on this enforced accelerated payoff.

Let’s re-examine that lifestyle question for a minute. What if you can negotiate a raise with your boss? What if you started a side hustle (like, say, blogging) to raise your passive income? What if you could share your lodging with a roommate and reduce your mortgage or your rent payment? What if you lived close enough to work to be able to ride the bus or a bicycle instead of using your car? What if you even (*gasp*) learned to live without your car and sold it? If you’re able to take these big, bad, bold financial steps then you’re no longer agonizing over whether to pay $200/month or $400/month on your credit-card debt. Instead of going to a P2P lender, you’d redirect your new lifestyle earnings & savings of at least $500/month straight to the credit-card company. You’d be debt-free in less than three years. The reality is that you’d be saving a good bit more than $500/month, and you’d probably be debt-free in under two years. Shucks, if you sold the car next week then you’d be debt-free in a few months.

Yeah, I hear you. Too hard. Ain’t got no time fo’ dat. Crosses the line from “frugality” to downright “deprivation”. You’d go nuts. Your spouse & kids would never put up with it. Your friends would tease you.

Well, just how good is your life right now, lugging around that $10K debt ballast? How much of your time do you spend worrying about your debt? How much better would your life be if you were swapping one debt for another and actually making a higher monthly payment? If you could implement even more radical cost savings in your budget then you’d be out of debt even faster, and afterward you could use your new lifestyle to accelerate saving for your own financial independence.

Remember, the reason that most people are considering a P2P loan in the first place is because they haven’t saved their own money. They may even be spending more than they’ve earned. Although a P2P loan could “solve” their short-term debt problem, the only thing that’s going to permanently solve their lifestyle problem is a new set of behaviors.

P2P borrowing looks like a good deal. Instead of paying ludicrously high interest to a faceless monolithic credit card MegaCorp, you’re paying slightly less interest to real people who are willing to take up a collection to help you get your life back on track. It’s very tempting, and the social proof of all those lenders is a warm & fuzzy feeling. But if you miss one of those P2P loan payments, or even come in a little late, then you’ll be facing a very different sort of peer pressure.

I’ve used the math of P2P lending to show you that it can get you out of serious debt trouble by forcing you to cut back to a shorter repayment schedule with higher payments. But if you can modify your budget to meet those higher payments, then why pay someone else to help you modify your life? Why not modify your life even more? The “old” version of you would have paid off the P2P loan, heaved a huge sigh of relief, and returned to your old lifestyle. Maybe you would have put that $300-$400 into your financial-independence account, but you haven’t really changed your behavior– you just forced your peers to change it for you.

However if you take the extra steps to really cut your spending (or possibly boost your income), then you’ll pay off your debt even faster than the P2P loan terms. Not only that, but it’s tremendously empowering to watch that debt balance melt away like an ice cube on a hot sidewalk. You’ve accepted the challenge of getting out of debt, but you’re not just paying a P2P lender to living under their rules. You’ve taken charge of your own life and your own spending, beaten your debt into oblivion, and freed up serious money to save for your financial independence.

Are you really sure you still need to be a P2P borrower? Do you really need to pay someone else 1%-5% of your debt to help you get out of debt? Would you like to develop your own financial muscles to keep saving for financial independence after you finish paying off the debt?

You’ve seen what P2P borrowing can do for you– but I hope this post has shown you that you can do even more for yourself.

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Filed Under: Finances · Tagged With: financial independence, military, military retirement, P2P, peer-to-peer lending

The problems with peer-to-peer lending

May 30, 2013 by Doug Nordman · 14 Comments

Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
This above all: to thine ownself be true,
And it must follow, as the night the day,
Thou canst not then be false to any man.
- Shakespeare, Hamlet

I’ve spent the last couple months researching the prospects of peer-to-peer lending. When you’re investing for financial independence, you’re interested in any asset class that beats inflation. If you’ve reached financial independence, then you’re thrilled to find a new source of passive investment income! If you “need” money, then P2P borrowing like a great way to cut through all that stuffy financial bureaucracy to borrow real money from real people just like you. P2P seems interesting when you can lend money at rates that beat today’s low yields on bonds and CDs. P2P is downright compelling when your lending generates a stream of nearly passive interest income from a diversified portfolio.

Looks pretty tempting…

The sector has executed its current business model for roughly five years, and in the last year it’s made a lot of progress. (It’s also been getting a lot of media attention.) If you’ve never even heard of P2P lending before then this post is going to give you a very broad overview of the process and its issues. Afterward I’ll send you off to other websites to investigate the nitty-gritty details of “how” and “where” to get involved.

If you’re following the press about P2P lending, and especially if you’re a customer, then this post is going to add a few links to the subject and focus on “why” you’d want to get involved. Or not.

Bottom line up front:

If you’re borrowing from a P2P lending company then you may already have a serious debt problem and need to change your financial habits. This is a good place to get out of debt but it might be your last chance. It’s time for a major lifestyle change or the next step could be a personal bankruptcy.

If you’re investing in P2P lending then you need to understand our human susceptibility to a number of behavioral-psychology delusions. The concept is extremely attractive but the risks are not easily perceived, let alone quantified. You will almost certainly lose some principal, but your yield should exceed those losses. However you may not be adequately compensated for your capital at risk.

Speaking from my three decades of unrelated investing experience, P2P lending seems like juggling chainsaws. Eager crowds will pay you a lot of money to do it, and if you do it with hard work & skill then you could end up rich– but if you get greedy or have bad luck then you might also end up with the nickname “Lefty”.

Before I get into the details, let’s look at the big picture.

The borrowing process

The traditional finance industry offers two basic choices for borrowing money: collateral or no collateral.

“Collateral” may be your home, a real estate investment property, your vehicle, your money on deposit with a bank, or your shares of stock held by a brokerage. If you can’t pay the interest or principal on your loan then the lender is eventually allowed to seize your collateral. If you’re willing to provide collateral to your lender, then you’ll get a lower interest rate. The more collateral you can offer (and the higher your credit rating) then the lower your interest rate– even as low as the car dealer’s “zero percent”. This is also known as non-recourse debt because the lender can only take your collateral and can’t come after your income or your other personal assets. A typical non-recourse loan is a home mortgage, and current rates on long-term mortgages are around 3-4%.

In my opinion, collateral is a very good thing. It gives the lender the confidence to loan you money. It also gives borrowers a limit. You’re rarely going to be able to borrow more than your collateral is worth, and it’s usually a major decision. Before you take out a $20K car loan (or a $350K mortgage) you’re going to do some serious analysis and consider whether this is really a good idea.

If you can’t (or don’t want to) provide collateral, then you’ll pay a higher interest rate. This loan is “unsecured” because there’s no collateral for the lender to seize. However the lender still has a “recourse” loan that allows them to pursue your income or your other personal assets. If you default on the loan (by missing a payment) then the lender could sell your loan to a professional collection agency, or take you to court to obtain a judgment against you, or otherwise attempt to shame motivate you into paying up. However the lender’s most practical alternative for a defaulted unsecured loan is to report it to a credit-rating agency that will trash your credit score. Even worse (from the lender’s perspective) a defaulted borrower could declare bankruptcy so that the lender would lose all recourse– and get nothing at all. Lenders are willing to take these risks because they’re lending relatively small individual amounts to a widely diversified group of borrowers at high interest rates, and defaults are relatively low. The classic example of an unsecured recourse loan is a credit card, and interest rates range from 6% to well over 20%.

Credit cards are the classic example of the bad things that can happen without collateral. Credit-card applications are a lot easier than car loans or mortgages. Heck, the lender may even pay you to take their credit card! You don’t have to make a major decision before you borrow the money– you just whip out your card and buy stuff. It’s way too easy to carry a balance and never pay off the loan, and it’s even easier to let the loan build up to a six-figure debt.

Borrowers aren’t the only examples of bad loan behavior. The finance industry is heavily regulated and scrutinized, yet the 2008-09 financial crisis showed just how far lenders can stray off the path before the market realizes there’s a problem. Collateral for non-recourse loans (real estate) turned out to be wildly overvalued and lenders were extremely leveraged on debts (mortgages) that turned out to have very poor chances of repayment (high default rates). Lending went bad so quickly that the system froze up and nobody was willing to lend to anyone without high-quality collateral. The federal government spent hundreds of billions of dollars to prop up the industry with cheap loans (in exchange for shaky collateral) until the leverage could be unwound, and five years later it’s still not over. Keep this liquidity issue in mind when we later discuss these startup lending companies whose business is “only” in the hundreds of millions– just a fraction of a percent of the “traditional” finance industry– and whose loans are completely unsecured.

Outside of the traditional finance industry, borrowers have a wider range of choices. Pawnshops are happy to lend you money on collateral (because they hold it for you until you pay them back). I buy a lot of bargains at pawn shops, which gives you an idea at how successful their borrowers are at repaying their loans. Casinos are happy to lend money to their biggest losers customers. The military is all too familiar with a wide variety of “payday loan” companies who typically want their money back by allotment from your next paycheck. (You indenture yourself to them with your own labor as collateral.) There’s also an interesting variety of “independent contractors” popularly associated with illegal gambling or organized crime. These lending institutions may have a shady reputation, but they’re all still heavily regulated and scrutinized. (I should also point out that despite their criminal reputations, they’re not the ones who nearly locked up the country’s financial system with the bad behavior of excessive leverage and irrational exuberance.) Most borrowers are discouraged from tapping these sources of funds, and I’m not going to consider them a practical source of loans.

[Let me re-emphasize that last paragraph for you military readers: do not use payday lenders. Peer-to-peer lending offers a better alternative than payday lenders. P2P loans are not your best choice, but they're far better than payday lenders.]

Finally, you can almost always find a friend to lend you money (at least for the first loan) and when all else fails there’s the Family Bank of Mom & Dad. Compared to all the other lending sources, these two may be particularly attractive sources of cash because they’re not bureaucratic institutions and they’re relatively willing to support you with a little fast cash.

The challenge of these last two alternative lending institutions is that they still depend on your reputation, whether that’s by credit check or by birth. When you “crowdsource” a loan from friends & family then you still have to persuade them that you have a good use for the funds, and that you’ll be able pay them back. The challenge is that you may have to contact a dozen people before you’ll find anyone willing to loan you money, and they probably won’t give you all the money you want. After you’ve phoned up a crowd then you may be discouraged enough to go back to an institutional lender.

But wait– what if the Internet could connect you with thousands of new contacts who were willing to lend you money while cutting through all the stuffy banker’s bureaucracy? What if borrowing money was as easy as eBay, PayPal, and Craigslist?

Borrowing from your peers

Most of the above lenders are trying to run a business and make a profit. When they issue a loan, they’re putting capital at risk. If they can’t hold your collateral (or grab it back) then just a few defaults would wipe out their profits and put them out of business. (And if you default on a loan from your friends or your Mom, then pretty soon you’ll be out of business.) The capital risks mean that the lenders have to charge a high interest rate to offset the occasional defaults.

But what if the lenders could sell your loan to someone else? Now they don’t have any capital at risk. They could continue to service your loan by collecting your payments and distributing them to the people who bought your loan. The mortgage industry does this all the time by selling your loan to other financial institutions who want to market loans as mortgage-backed securities. Mortgage companies still have to check your collateral and set up a non-recourse loan, but that’s regulated by the foreclosure process. They don’t have their own capital at risk anymore, so they can hypothetically offer you a lower interest rate.

Now what if the lending company could cut out most of the lending expenses? If they could lend money at lower rates then they’d get more borrowers. If they could sell high-yield loans to investors then they’d get more lenders. The trick is to charge borrowers a lower interest rate than a credit-card company (less than, say, 25%/year) while paying investors a higher yield than most bonds (more than, say, 10%/year). If they get rid of all those pesky collateral requirements then the interest rates are even better and they reduce their business expenses even more. By cutting out most of the expenses (and all of the middlemen), the company could eke out a profit and then grow the business.

Over the last decade, peer-to-peer lending companies have been re-building the loan-servicing business model. If you want to borrow money from them then you still have to fill out an application. You have to offer personal information and agree to a credit check, and perhaps you have to supply more documentation for verification. In exchange, the P2P lending company guesses decides how likely you are to repay your loan and what interest you should pay.

Then, before they even give you any money, they see who wants to buy your loan. Just like eBay, they throw your loan application up on their website for their eager lenders to bid on it. Lenders have barely enough financial information about you to entice them to lend you money while not actually knowing who you are or where you live. They don’t really have to care because they’re doing this with hundreds or even thousands of borrowers.

I can only imagine how complicated & painful this business model must have been to create. For example, the financial institutions that buy mortgages are willing to tie up their capital for nearly three decades. Unfortunately there aren’t many individual investors willing to tie their money up in a seven-year CD, let alone a 30-year mortgage. If a peer-to-peer lender holds the loans (or lends the money for too long a term) then the government regulates them as a bank. If they sell shares in the loans then they could be treated as a company selling shares of stock and regulated by the SEC. If P2P lenders charge too much interest then nobody will want to borrow money. If they charge too little then investors won’t buy their loans. They have to charge fees for their business to make a profit, but if they charge too much then someone will inevitably find a way to undercut them. Above all else, the company has to scale: it has to reach a critical mass of customers in order to make the business worth building, but then it has to be able to handle millions more customers at very little cost.

How P2P lending works

Luckily for the P2P lending industry, the cost of developing a Web-based financial business has dropped tremendously over the last decade. A few brave (or incredibly optimistic) entrepreneurs managed to raise enough seed capital from even braver (or more deluded) investors to build a website and the business process. Then they started recruiting customers.

When you decide to borrow money, you sign up with the P2P lender. You promise not to lie and you give them enough personal info for them to run a credit check on you. Your credit score and your income could be the only justification for the interest rate that they offer you, or you could volunteer more documentation (tax returns, employment verification) to persuade them to lower the interest rate a little more. (Or maybe they don’t want to waste their time & money on verifying your documentation.) For various legal and cost reasons that have been worked out over the last decade, your loan term is only 3-5 years. This short term means that your monthly payments will be a lot higher than you’re used to seeing from mortgage banks and credit-card companies. The annual interest rate on most loans will be between 6% and 35%. The maximum amount that most P2P companies will give you is $35,000, but if you’re a typical customer then you’re probably seeking $5000-$15,000.

The P2P lender uses an automated process to set the interest rate on your loan. It’s a complicated algorithm based on default probabilities, statistical history, and lender experience. It’s difficult to develop and it costs a lot of money to build. (Hopefully it’s cheap to maintain & tweak.) But let’s be honest here: it’s sophisticated guessing at your default risk and how much interest you’re willing to pay. It’s a mathematical model that may only overlap reality by 99%, and we all saw what happened in that 1% area during the Great Recession.

As a borrower, you’re getting a recourse loan with no collateral. You agree to pay the principal & interest on schedule, as well as any late fees. If you default then your credit rating will be trashed, your credit score will drop by over a hundred points, and your loan will be turned over to a collection agency. The collection agency will pursue you and might even seek a court judgment against you. (That’s the “recourse” part of a recourse loan.) If you’re in the military, a loan default makes you a security risk. The only legal way you can escape the collection process is to declare bankruptcy. Of course bankruptcy also has a devastating effect on your credit history (and your security clearance), but hopefully you’ll work out a repayment plan with the collection agency– or possibly even be completely excused from paying the loan. Good luck with that.

The “peers” who lend you their money are hypothetically capable of understanding (and affording) these risks. They have to agree to the lending company’s rules and qualify to be their lenders. They’re getting a much higher yield on their capital than they’d earn in most stock or bond markets, so they may decide that they’re being adequately compensated for their risks. The vast majority of them are only going to lend you a little bit of their own money: typically $25-$200 per person. The lenders do this to spread their own capital among a widely diversified set of borrowers so that they’re not hammered (too badly) by defaulting borrowers. This means that your loan will only be funded if enough suckers volunteers step forward to supply the cash. From what I’ve read, there are plenty of eager volunteers.

The lending company has their own fees. They’ll collect a funding fee from the borrower of 1%-5% of the loan amount, but that’s deducted when the money is sent to the borrower. They collect a processing fee from the lenders of 1% on the payments. Notice that until the loan is actually funded and the borrower starts making payments, the lending company is working for free. They don’t get anything up front, and they only make money if the lenders agree to fund the borrowers. If the borrowers are late on payments then the lending company can collect additional fees, but late-paying borrowers have an unsettling tendency to become defaulted borrowers.

Before you borrow

From a borrower’s perspective, the P2P companies and the lenders are both eager to lend you money. Really, really eager. They’re so eager to lend you money that you should worry a little about why they’re being so nice to you. A future post will tell you why there are so many enthusiastic peer-to-peer investors & lenders out there, and why P2P may still be a much better deal for a borrower than for a lender.

If you’re thinking of borrowing money from a P2P company, first you have to address a bigger problem: Why are you willing to pay high interest rates for a no-collateral (unsecured) recourse loan?

The answer is simple: You’re spending more than you earn. You want to stop doing that.

I completely understand if you’ve been hit by a big medical bill or an unexpected car repair or a large emergency travel expense. I empathize if you need to borrow money to adopt a child. However in the first case you can negotiate far better payment terms with the hospital than with a P2P lender. In the second case your car could serve as collateral for a cheaper loan. In the third case then you might be able to borrow from friends or family before approaching a P2P lender. If you’re adopting a child, I applaud your altruism– but you should save as much money as you can before the adoption in order to pay for the greater expenses of raising your family. And after you recover from these situations, you should build up an emergency fund to help soften the financial impact from a future crisis.

If you’re in the military then you have other options. You could negotiate a repayment plan with the debtor, especially if they’ll accept an allotment from your paycheck. You could seek assistance from a military relief organization, including debt counseling & consolidation and even possibly an interest-free loan. If you’re facing extra expenses for a transfer then you could get an advance on your pay or on your travel claim.

If you want a P2P loan to start a business, then maybe you’re doing it wrong. Go find some customers and get them to front you a little money to solve their problems. Go find an incubator to coach you in return for a little of your equity. If you’re solving the right problems then you don’t need a P2P loan. If you’re solving the wrong problems then you need a different business model. If you need to grow your business (because it’s already successful) then read more about angel investing at VentureHacks.

If you’re trying to pay off your high-interest credit-card debt with a lower-interest P2P loan, then be very careful. A P2P loan will be for a much shorter term, so even if you’re paying a lower interest rate then you may still be paying higher principal payments. In addition, credit-card debt happens when you spend more money than you earn. If you get a P2P loan to pay off the debt, you still have the problem of spending more money than you earn. You may need to stop using your credit cards and possibly even seek financial counseling. Otherwise a P2P loan is just adding a second problem and helping you spiral ever deeper down the debt toilet toward bankruptcy. The next post will compare P2P loan payments to credit-card payments to help you choose your option.

If you’re seeking a loan for a vacation or home improvement or an engagement ring or a wedding (as encouraged by P2P company websites), then you need to re-think your priorities. To be blunt, you earn the pleasure of these experiences by saving up for them. Show some commitment to yourself and your significant other: cut your expenses and save for these goals.

If you’re still considering borrowing P2P money, then use a loan calculator to check your payments. Remember that these are short-term loans, so they’ll absorb a significant chunk of your paycheck. The next post will list the major P2P lending parameters and supply a calculator for you to estimate your payments.

There. I’ve tried to talk you out of it. If you insist on borrowing P2P money, then only do it once. Get out of debt, cut your expenses, build an emergency fund, and get back on track to build your net worth. But if you can do that, then the next post will also show you how to do it without a P2P loan.

If you’re still keen on borrowing from a P2P lender, the two biggest U.S. companies are Lending Club and Prosper. Lending Club does not offer loans in Iowa, Idaho, Maine, Mississippi, North Dakota, Nebraska, or Vermont. Prosper does not offer loans in Iowa, Maine, or North Dakota. (Maybe these states are on to something? The website roster varies occasionally from the company’s prospectus, so check those links before you apply.) I’ll update this post as the situation changes, so let me know what your state does to approve P2P lending.

Prosper even targets the military for specific loan purposes, but you should check rates with both companies. Once again, if you’re in the military then you have better options to pay for military-related expenses. You’re also protected by the Servicemembers Civil Relief Act (see the link below).

Before you borrow, please read my upcoming posts on estimating your loan payments and on why lenders are so eager to throw money at you.

If you’re a lender, then please keep your wallet in your pocket until you read the next two posts.

3 June 2013 update: Here’s the second post, which reviews P2P loans from the borrower’s perspective and includes a calculator to help decide whether the payments are affordable.

6 June update: Here’s the third post, which reviews P2P loans from the lender’s perspective.

Lending Club
Prosper

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Filed Under: Finances · Tagged With: military, P2P, peer-to-peer lending

Book review: “The Longevity Project”

May 27, 2013 by Doug Nordman · 10 Comments

“Come on, you [men], do you want to live forever?!?”

– Marine Corps First Sergeant Daly, Belleau Wood
(slightly edited for a family-friendly blog)

One of the challenges of financial independence is “longevity risk”, where you ensure that your assets will last as long as you do. Unfortunately when we stop working for a paycheck (even at the “traditional” age of 65) most of us have no idea how long our assets will have to last. If you stop working in your 40s then the actuarial odds are pretty good that you or your spouse will be around for another five decades. Even the Internal Revenue Service has noticed the issue and revised the IRS required minimum distribution tables to reflect longer lifespans (and lower RMDs). Financially, the only way to hedge longevity risk is through annuities like a military retirement, Social Security, or an insurance contract.

But longevity is not just financial probabilities and statistics. If you’re going to minimize your financial longevity risk, how can you also maximize your longevity? For example, Dominguita Velasco turned 112 years old on Mother’s Day. That’s not a typo: one hundred and twelve years old, yet she’s barely in the top 30 centenarians whose ages have been authenticated. They’re humanity’s fastest-growing age group.

So what’s Ms. Velasco’s longevity secret? “Stay happy.”

The researchers of “The Longevity Project” have nearly a century of data, but it fails to confirm Ms. Velasco’s insightful analysis.

The book cover of "The Longevity Project" on what promotes long lifespans.

How long will you live?

The data came from a study that began in the early 1920s when a Stanford psychologist interviewed over 1500 elementary school children. Dr. Terman was looking for bright kids whose intellectual potential might be identified by its early signs and tracked to its fulfillment. (Terman invented the Stanford-Binet IQ test, which is still in use nearly a century later.) He checked back with his group every decade or so until the early 1950s, and then followup interviews were carried on by his successors. When “The Longevity Project” authors began their study, they spent a tremendous amount of time and effort tracking down all the death certificates of the participants. By verifying their subject’s ages and causes of death, they completed the collection of one of the 20^th century’s largest and most detailed databases of human health and longevity.

The children profiled by Dr. Terman were born between 1900-1925. A few of them lived into their 90s and as of 2003 over 200 of them were still alive. They dealt with the Great Depression, a world war, and the Cold War. They led America’s 20th-century expansion in population and technology, and they represented a typical segment of its middle class. A few found fame & fortune and some were well-known in their professions. They also died at all ages and of almost every cause, so the researchers could test many theories about the factors affecting their longevity.

Several books have been published on the study. “The Longevity Project” represents 20 years of analysis by Doctors Friedman & Martin, assisted by over 20 graduate students and other PhD collaborators in various research specialties. They explored the data from many different aspects and then compared their results to other (shorter-term) studies in physiology, psychiatry, sociology, mental health, and aging. They were even able to compare some of their data to the Grant Study, another longitudinal database of 268 Harvard undergraduates that continued for 75 years.

By today’s standards, Terman’s original study was flawed. The chosen children were recommended by their teachers and selected for IQ results. They were overwhelmingly white, middle-class, and from California. They were also a product of their times, when women had limited opportunities while these particular men were offered exceptional favor for their gender and race. Dr. Terman interfered in the study by writing recommendation letters for some of his subjects and even exerted his influence to get others admitted to Stanford. Years later, however, he concluded that IQ did not correlate to achievement. After modern researchers accounted for the study’s flaws, they agreed with him.

Friedman & Martin looked at longevity, not potential or achievement. They debunked some surprising conventional wisdom of their own. Based on their data, all of these myths appear to be false:

The good die young.
The bad die late.
Married couples live longer.
You’ll live longer if you take it easy and don’t work so hard.
Happy thoughts reduce stress for a long life (contrary to Ms. Velasco et al).
Worrying is bad for your health.
Don’t be so serious. Be more spontaneous and have more fun.
Religious people live longer.
Vigorous exercise is better for longevity than gardening or walking.
You’ll live longer if you believe that you’re loved and cared for.
You’ll live longer if you retire as early as possible.

So what works? Surprisingly, the words “prudence” and “persistence”. Children who Terman had assessed as “conscientious” were highly correlated with longevity. Modern society is all too familiar with the Darwin Award for a lack of conscientiousness (“Eh, brah, hol’ ma Primo an’ watch dis!”) and more conscientiousness also promotes longevity. It not only leads to healthier habits but to better friendships, improved workplaces, and happier marriages.

What’s wrong with thinking happy thoughts? It turns out to be a two-edged sword. There are positive health aspects to being cheerful, but it can also result in a happy-go-lucky disregard for health. Centenarians like Ms. Velasco are optimistic, but the problem with studying this age group is that darn near all of them are smiling. There’s no comparison group (the ultimate “survivor bias”). Happiness seems to be a result of longevity, not a cause of it. It’s more likely that they’re happy only because they survived so long– not because lifelong happiness makes them healthier. Ironically, some studies determined that worrying and neurotic behavior were better survival tactics than maintaining a cheery outlook.

Since this is a blog about financial independence and retirement, I’ll skip ahead to the end of the list. Does early retirement really reduce your longevity? If that’s the case then I’d better type faster.

The most notorious claim relating early retirement to early demise is the Boeing Study. Although it’s been debunked, it regularly resurfaces and resonates across the Internet. Other studies purporting to prove the same conclusion do not distinguish between early retirement for health reasons versus early retirement for financial independence. Once the data is corrected for that difference, there’s no correlation between early retirement and shorter lifespans.

There’s also no correlation between early retirement and longer lifespans! In fact the data seems to conclude that working longer leads to extended life. “The Longevity Project” authors analyzed this hypothesis against their data and determined that the actual workplace correlations to longevity are conscientiousness, prudence, persistence, and productivity. If you satisfy those factors through working for a paycheck then you’ll live a long life. If you satisfy those same factors by reaching financial independence and retiring early, while still maintaining your personal productivity, then it also turns out that you’ll live a long life. If you retire early due to poor health, or if you retire early to vegetate on the couch all day (perhaps sipping margaritas and nibbling bonbons), then your longevity is also dramatically reduced.

By the way, the definition of “retirement productivity” is up to you. In the workplace it’s usually measured by happy customers, meeting deadlines, and cashing paychecks. If you’re financially independent then it’s whatever you find entertaining and fulfilling. That could be training for an Ironman triathlon, working on your house & garden, painting portraits, or simply reading & writing. If you’re active and happy then you’re probably healthier and more likely to live longer.

If you’re curious about marriage and religion, you’ll have to read the book. (It’s been out for two years so you’ll probably find a copy at your local public library.) The important longevity factors turn out to be the quality of those two institutions for their participants, not merely their membership.

Despite the flaws of the original Terman research, “The Longevity Project” is still the world’s best collection of lifespan data. Regardless of why it was started, it offers insights on what led to long life in the 20^th century. Death certificates are objective evidence of the cause of death, and a tremendous amount of data was collected on these people as they lived their lives. The analyses conducted by Drs. Friedman & Martin are peer-reviewed, statistically rigorous, and frequently confirmed by other sources.

Better yet, applying their recommendations won’t require any radical lifestyle changes. We can pick & choose from their results and implement the concepts which suit our confirmation bias. Just by reading the book and reflecting on our own lifestyles, the placebo effect can practically guarantee an improvement in our own longevity.

One day you, too, might be offering the media your own analysis of how you managed to stay alive for so long. And when you do, you’ll be happy about it!

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Filed Under: "What do you DO all day?!?" · Tagged With: early retirement, financial independence, longevity, military, military retirement

How to support disaster relief (and rebalance your investments)

May 23, 2013 by Doug Nordman · 4 Comments

It’s that time of year again: storm season. The Oklahoma tornado disasters have me reviewing our Hale Nords hurricane readiness plans and tackling the time-consuming tasks like roof repairs. I’m married to a meteorologist who’s a military-trained Emergency Preparedness Liaison Officer, so there’s no slacking on our checklist. I’ve been through a few natural disasters and if I ever have to experience another one, I want to know that this time I’ve really done everything I could to be ready. Of course you’re never really ready to hear those sirens start wailing.

Last week I was only dimly aware that hurricane season is approaching. Instead, my spouse and I have been casting a wary eye on our retirement investment portfolio. After nearly six years it’s returning to new highs, and we all know how that trend ended the last time. Our asset allocation and our rebalancing triggers are subjects for another blog post, but one part of that process is our Fidelity charitable gift fund.

So rebalancing and donations were already on my mind when the Oklahoma disaster struck, and this is a good time to look at a different way to give money to relief organizations while rebalancing your portfolio.

Ideally we’d all have a philanthropic donation plan just like our investment plans. We’d choose our charity goals just like our asset allocations, and we’d regularly support our chosen organizations in ways that maximize their benefits.

However we humans are just as emotional as we are logical, and when disaster strikes we feel a strong affinity for helping others. Bankrate.com author Judy Martel, a CFP and an expert on family wealth, has a few suggestions on how to donate to tornado victims. When we impulsively give $50 to the Red Cross or one of the other organizations on her list, it makes us feel better next time the video & photos start scrolling across our screen.

But where is that $50 coming from? If you’re striving for financial independence then you’re already running a budget. It probably lacks a category for “miscellaneous charity donations”. You might allocate part of your spending to charity, but the organizations that you normally support are still every bit as deserving of your donation as the Oklahoma tornado victims. You’re probably pulling that $50 out of some other cell in your budget spreadsheet. If you’re planning to donate more, like $500 or even $5000, then it’s a lot more than just a part of your monthly budget.

You could pull the cash out of your emergency fund. However most people want their emergency fund to support their own personal emergencies so that they don’t need a relief organization. Cannibalizing your own emergency fund to help someone else is not in everyone’s best interests. Besides, you never want to get in the habit of frequently withdrawing “just a little bit of money” out of your emergency fund.

There’s another source of funds: your investments.

If you’re reading personal-finance blogs then you’re probably already familiar with the concept of rebalancing your investment accounts. You bring your asset allocation back to your personal comfort level by selling some assets (presumably at a gain) and using the cash to buy other assets (ideally on sale). You do it annually or whenever your chosen allocations get too far out of whack.

It’s fairly easy to sell assets from a taxable account, transfer the cash to your checking account, and then write a check to your chosen charity. However when you sell appreciated assets in a taxable account, you pay taxes on the gains. Now you have to have a little more cash available to pay your tax bill, and your $50 donation to the Red Cross has been contaminated by another involuntary donation to the U.S. Treasury.

That’s the beauty of charitable gift funds and donor-advised funds.

[There may be some legal distinction between those two terms, but I'm going to use them interchangeably as "CGFs".]

The Internal Revenue Service already lets taxpayers donate many types of appreciated assets to charities without (in most cases) paying taxes on the gains. Your charitable donation means that your profits on the sale are no longer subject to tax. In fact, if you meet the additional IRS limits on your other income and deductions, you may even save a little on your tax bill. I’m just a personal-finance blogger, so please seek professional advice before trying to save a little on your own tax bill.

In the past this meant obtaining actual paper share certificates, physically signing them and turning them over to the charity, and then having the charity cash them in to obtain the funds for their programs. In the 1990s, however, investment firms began acting as intermediaries. Instead of sending you a paper certificate they’d transfer the shares electronically to their own charitable funds. You, as the donor, could “advise” the fund on how you want to distribute the asset that you just donated. Three of the largest CGFs are run by Fidelity, Vanguard, and Schwab.

The fine print of a CGF agreement says that they’re only going to distribute your contributions to approved charitable organizations. You can tell a CGF to send your donation to support tornado victims in Oklahoma when there’s an IRS-approved charity for that cause. Even then you might only want your contribution to go to that charity if you feel that they’re responsible stewards of your money. However by the time you read this post, all major CGFs will have suggestions on their websites for where your tornado relief contribution will do the most good.

Although the CGFs are sending money to charities, they’re not completely altruistic. Fidelity will deduct a fee from your account every quarter, and the other fund companies will cover their expenses either with similar direct fees or through processing costs. However you can send appreciated shares to these funds much more efficiently via electronic transfers than by paper share certificates in the postal mail, and I think their fees are well worth the convenience. Best of all they’ll track your donations and your charitable distributions while sending you the appropriate tax forms.

Now when you want to send $50 to the Red Cross, you can sign up for an account at one of the CGFs. If you already own funds at Vanguard then it’s probably easier to set up an account at Vanguard’s CGF, but you can transfer your shares electronically among almost all major financial companies and a CGF of your choice. If you’re transferring shares from your Schwab account to your Schwab CGF, then it also happens overnight instead of over 3-4 days.

Next you have to choose which of your investments will provide the $50. You’re probably going to pick the fund or stock that’s appreciated the most (for the largest capital gain) or the asset class that’s farthest above its desired allocation. Instead of selling shares and transferring the cash to your checking account, you’re going to transfer the shares directly to the CGF account. Your trade will go through at the next available transaction price and $50 worth of shares will disappear from your taxable account. The CGF will let you deposit those shares into another investment fund if desired, but since you’re sending the money straight to a charity then you’ll probably direct them into the CGF’s money-market fund.

Once the shares have cleared the CGF’s processing and are credited to your account, you’ll select the Red Cross for a grant of your $50 worth of shares. Since the Red Cross is already on the CGF’s list of IRS-approved charitable organizations, your grant recommendation is immediately approved. The money-market fund shares are cashed in and $50 is transferred electronically directly to the Red Cross’ accounts. A Red Cross volunteer in Oklahoma uses the money to buy supplies for a shelter or hands a debit card directly to a hurricane victim.

That’s all it takes. The Red Cross has your $50 in Oklahoma faster than you could have tossed the cash to a volunteer. You didn’t have to write a check or deplete your emergency fund. You didn’t have to pay taxes on the donation, and the CGF will send you the IRS form in time for your next tax return.

By the way, you’ve just done a little rebalancing in your investment accounts. Now you can relax a bit and enjoy the stock-market trend.

[This example was for assets in a taxable account, but if you're older than 70½ then you can also make a charitable donation from your IRA. If you're younger than 70 ½ then you're going to have to wait until you're old enough to qualify to use your IRA for charity.]

Other charitable gift fund conveniences.

When you have the fund send a grant to a charity, you can tell the charity how you want them to recognize your donation. CGFs do the task for you in your name. You can use the CGF’s website to designate the grant “In honor of…” or “In memory of…”. For example, revenues from “The Military Guide” are donated to their military charities “In honor of the contributors to the book ‘The Military Guide to Financial Independence and Retirement’.”

You can distribute the grant for a specific purpose. When you send it to a large organization like the Red Cross without any conditions, they can use your “unrestricted” grant wherever they want. It’ll probably go to hurricane relief but it could also go to a local Red Cross chapter in your area, or it could be used to buy laser printer toner cartridges at the Red Cross headquarters office. If you check the box labeled “Use the money where it’s needed most” then it’s spent on their top priority for their annual program plan. When you specify “For relief efforts to Oklahoma hurricane victims” then that’s how they’re required to spend it.

You can send the grant in your name– or not. If the charity receives a donation letter from your CGF with your name on it, then the charity can put you on their mailing list and contact you directly. Even worse, some charities will sell their mailing lists to other organizations who will send you their own appeals. When you’re trying to help hurricane victims, it’s annoying to see a hurricane of unsolicited mail descend on your own house. However you can tell the CGF to make your grant anonymously, and the charity won’t be able to send you monthly appeals or other invitations. Now the charity is spending contributions on relief efforts instead of sending you junk mail.

My spouse and I really appreciate distributing anonymous grants. We don’t want the charity wasting our money on direct-mail fundraising expenses. We have a philanthropy plan, and we might want to change it without the charity sending us reminders or guilting us into donating more. We know how much we’re doing, and nobody else needs to know that information. You’ll never see my name on a park bench, let alone a hospital wing.

Now that you’ve set up a CGF account, you can make donations to it at any time. You can do your tax planning separate from your charity support. Instead of waiting for a specific event at one of your philanthropic organizations you can transfer appreciated assets to a CGF now, stash the funds in a money-market account, and wait for a charitable event to recommend a grant. This means that you can carry out your philanthropic plans on your schedule (quarterly donations or whenever you rebalance) and distribute grants to your chosen charities on their schedule (emergency relief, matching donation challenges, fundraising drives, or other events). We rebalance our investments every 2-3 years, and we transfer enough of that to our CGF’s money-market fund to fund three years of annual grants.

A CGF lets you organize your philanthropy and put it on autopilot. If you decide to add hurricane relief to the causes that you support, then you could use your CGF’s website to schedule an annual grant from your taxable investment account. It could be sent anonymously every March to the Red Cross in memory of someone (or in their honor) to be used for hurricane relief efforts. Now when you see a hurricane on the news, your heart still goes out to the victims. However you also know that you’re already supporting the relief efforts with your donations and grants, and you can even impulsively log into your account to send more.

A charitable gift fund is a great way for us to use our emotional investor psychological behavior to help others.

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Filed Under: Finances · Tagged With: disaster relief, financial independence, military, Oklahoma tornadoes

TRICARE Prime premiums and United Healthcare

May 20, 2013 by Doug Nordman · 10 Comments

[WARNING: HEALTH INSURANCE RANT]

I’ve been a healthcare “past due” delinquent since April.

Even worse, I risked losing our family’s health insurance due to a bureaucratic glitch. It wasn’t my bureaucratic glitch, but we would’ve been without health insurance.

One of the most common concerns among retirees is “But… but what will I do all day?!?” I’m about to give you a glimpse into the downside of that question. I’ve certainly been doing something all day, and I wish that I never had to do it in the first place.

Are you in Tricare’s Western Region?

As some of you readers are aware, the Tricare Western Region has changed contractors from TriWest to UnitedHealthcare. (That’s not a typo. They actually spell their name on their letterhead with no spaces but two capital letters.) The “new” contract was first awarded to TriWest nearly four years ago but has been beset by challenges and appeals. It finally played out and UnitedHealthcare took over on 1 April.

In this case, however, “took over” is not the same as “seamless transition”. You may have seen the announcement from Tricare that referrals for their Western Region Prime members were waived ~~through 18 May~~ * due to UHC’s apparent inability to keep up with the requests. (With almost four years’ delay before they took over the contract, you’d think that UHC would’ve had time to figure out the process and determine how many people to hire. Or maybe they could’ve just hired TriWest’s referral staff. But I digress.) I have to admit that I was tempted to leap into that loophole and see a specialist about something– anything!– but regrettably I’m in decent health.

* [Update at 2 PM PDT: Tricare's UnitedHealthcare referral waiver has just been extended for another month through 18 June 2013.]

Back in March (before they took over the contract) UHC sent me a form to set up automated payments. As has recently been explained to me, the form had two parts. The first part asked for the usual information like a routing transaction number, a bank account number, and my personal information. This would be used to set up an electronic funds transfer to withdraw the monthly $44.88 Tricare Prime family premium. No problem there.

The second part of the form asked for three months’ premiums up front. I don’t remember whether I could do that with an EFT or if they wanted a credit card number. (Foolishly, I neglected to make a copy of the paperwork before I mailed it in. It’ll be a long time before I trust UHC at that level again.) I remember that in 2002 I had to pay in advance (when I retired), but this time UHC was taking over the contract from TriWest. They were going to simply take over the EFT payments that I’d been making for over a decade, so why would they need more money in advance? Even worse, I could imagine a scenario where the new crew would deduct $134.64 the first month and then start the EFT on the second month. I’d lose two months of premiums in the first month and have to spend many more months straightening out the error.

In retrospect, a different form for existing retirees (or a cover letter) could have mentioned that the credit-card charge in the second part would cover three months of premiums and the EFT would resume on the fourth month. But it didn’t say that because UHC tried to make the existing form cover all situations.

So I made a fateful mistake: I wrote “N/A” for the second part, signed the form, and sent it back in the mail.

In early April, a few days after TriWest left the building, I noticed that $44.88 had not been deducted from my checking account. I decided that UHC needed time to get caught up, and I forced myself to wait. Besides, I was pretty sure that the call center would be overwhelmed with new employees and thousands of other beneficiaries wondering when their premiums would be deducted.

That question was cleared up on 10 April when I received a “Past Due” notice. My first thought was to use their website to straighten out the problem. (And, um, the UHC call center computer suggested that about eight times too.) Of course I had to register for the website, and then I had to confirm, and then I had to log in, and then I was finally ready to e-mail them about the billing statement.

However I couldn’t e-mail UHC because they don’t list an e-mail address on their website. They didn’t even have a “Contact us” form. At this point they’d been “in charge” of the Tricare Western Region for just about two weeks, so maybe they’ve caught up to that oversight by now. But after spending 30 minutes on their website, it turned out that I still needed to phone them up.

I’m not sure how much time I spent on hold, but it must’ve been less than 15 minutes. Not bad for a new contractor. When the rep came on the line, he had my account on his monitor and he could actually see my EFT form. He wasn’t sure why it hadn’t been processed yet and he speculated that it was due to the backlog of changing over the contractors. He said that the $44.88 would be deducted. I asked about the second part of the form and he said that was just for people who wanted to make quarterly payments instead of monthly deductions. He actually said “Don’t worry about it.” That made sense. Good to go. Thanks!

Well, not so fast. On 10 May I got another “Past Due” notice, so by now I was two months delinquent. I was still in good health but I could feel my blood pressure rising. My stress hormones were probably boosting my cholesterol levels, too. I was reluctant to phone the call center again because I thought I’d get the same explanation, even if I asked for a supervisor.

I decided to see if UHC’s website had an e-mail address on it yet, but I don’t know the answer to that question because I can’t log in. It either doesn’t recognize my password or it’s overwhelmed with server traffic, but I’m not going to try to solve that problem this month. Maybe this fall, when business has hopefully settled down, I’ll reset my password and see if I can get back in.

I finally gave up and called UHC’s phone number again, but they were closed for the weekend.

I decided to pull out the heavy artillery and contact Tricare.mil, the supervisor of the contractor. However they only have an information website and apparently they don’t offer their own customer service– that’s handled by the contractors. No matter where I went on Tricare.mil or UHC’s website, I kept getting nudged back to the same phone number.

Then I noticed that Tricare.mil has a grievance process. Aha! That would get someone else involved who could help straighten out the call center’s confusion.

When I clicked on that link, it popped up a PDF and said that I’d have to fax it in.

I don’t know about you guys, but I haven’t had to send a fax for myself in at least three years. I think it’s dying tech that’s being replaced by e-mail attachments and secure websites. (We even refinanced our last mortgage by scanning & e-mailing dozens of pages without a single fax.) “Luckily”, I still have a fax machine because my Dad’s long-term care insurance company insists on receiving a monthly fax from me after I pay his invoice at his care facility. So I filled out the “online” grievance form PDF, printed it out, signed it, and faxed it to UHC.

The grievance got immediate attention. It wasn’t just heavy artillery– it was lobbing a tactical nuclear warhead. On Monday I was phoned by a supervisor who was at least two levels up from the call center. She was so high up that she had to bring someone else on the line to actually complete the paperwork. To her credit, she professionally explained why the form hadn’t been processed by UHC. I didn’t get any “You have to understand…” or “What I need you to do…” attitude. She just said that the April and May payments could no longer be deducted via EFT, and that they were nearly at the deadline for the June EFT. She proposed that I pay those three months over the phone with a credit card, and then they’d process the EFT paperwork to make the first premium deduction from my checking account in July. She brought on the rep to do that, we swapped numbers and confirmations, and now Ohana Nords is insured again.

By the way, when I answered the phone she asked for me by rank. I don’t know about the rest of you veterans, but these days when someone addresses me by my active-duty rank it makes my sphincters clench with the fear that I’m being mobilized. I guess Tricare asks their contractors to do that in order to honor our service.

I probably never lost any health insurance coverage, but it would’ve been darn hard to figure out how to contact someone at UHC or Tricare to confirm that. If we’d been injured or sick it would have been even more stressful. I hope UHC gets their payments and their referral system straightened out soon, but (as usual) it seems that the best healthcare is: prevention.

[END RANT]

One or two of you Western Region beneficiaries may be having similar problems with your Tricare premiums. If that’s the case, then first you should try to resolve the issue through their call center. If that doesn’t take care of it, however, then you could download the “Grievance Form” PDF, fill it in, print it out, and fax it to 877-584-6628. That seems to focus the correct level of management attention on the problem.

Or at least I hope it did. I’ll confirm that during the first week of July.

I should mention that while (so far) UHC’s customer care leaves a lot to be desired, I’m still happy with military Tricare Prime and its premiums. Health insurance and healthcare expenses are two more major worries of civilian retirees, and we military beneficiaries can easily lose sight of how good we have it compared to the rest of America’s citizens.

Have you had any problems with the new Tricare Western Region contractor? How have you solved them?

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Filed Under: "What do you DO all day?!?", Military · Tagged With: customer service, military, military retirement, Tricare, Western Region

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