The stock market has historically been hard to beat when it comes to long-term returns. However, there are several reasons why the growing world of alternative lending could be better for long-term investors than the stock market at current levels.
What Is Alternative Lending?
Traditionally, the best way for lenders to gain returns on their cash in fixed income has been to “lend” it to banks or other financial institutions by investing in CDs or other fixed income investments. However, the new trend toward online lending allows lenders to lend directly to borrowers by browsing online databases and hand-picking preferred borrowers. Rates, terms and risk levels are all determined without the involvement of a traditional bank, and loans are made directly through an online lending platform.
What To Expect From The Stock Market
For decades, investing in the S&P 500 has been one of the best sources of long-term returns. In fact, since 1928, the S&P 500 has returned an average annual yield of 11.5 percent. While it’s true that this type of return is hard to beat historically, the current market environment is far from typical. Following a huge, six-year post-Financial Crisis bull market, the S&P 500 is up about 200 percent since March 2009 and is currently more than 25 percent higher than its pre-crisis all-time highs. There are very few valuation metrics that indicate that the S&P 500 remains undervalued at this point. The index’s price to earnings ratio (PE) is currently 20.0, well above its historical mean of 15.5. Even though the S&P 500’s current 12-month forward PE of 17.4 is slightly lower, it’s still hard to argue that the market is currently undervalued.
A Lost Decade?
John Bogle, founder and former CEO of The Vanguard Group, said earlier this year that he sees very little upside for traditional investors over the next decade. He projects 2-3 percent bond yields and about 4 percent overall returns from the stock market over the next 10 years. “When you factor in the costs associated with index funds, inflation and taxes, you are actually looking at real returns of nominal to zero,” Bogle explained. If Bogle’s projections are correct, “nominal to zero” is a far cry from 11.5 percent annual returns, and stock and bond investors could currently be staring down the barrel of a lost decade.
According to the latest numbers from Lending Club, an alternative lender, the average two-year aged portfolio is currently yielding average returns of between 6.2 percent and 8.7 percent. Depending on risk tolerance, even higher rates of return are available for lenders. While there is certainly always risk of borrower default, these types of returns are less volatile than stock market returns. For example, the S&P 500 recently dropped 11 percent in less than a week, eliminating more than a year of gains in a matter of days. Investors that have chosen quality borrowers can sleep much easier at night than stock market traders, who live in constant fear that one bad economic headline could wipe out years of progress overnight.
At many times throughout history, the stock market has been the best place to go for large returns on investment. Unfortunately, it appears as if the next decade may not be one of those times. If you are looking for a creative solution to a potentially stagnant stock market, want access to higher returns than you can get from a bank and understand the risks involved, you should consider dipping your toes into the world of alternative finance.
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