Why do I want to calculate my Internal Rate of Return (IRR)? To make sure it is higher than my cost of money – ergo a good investment. I claim that my cost of money is 5% which I can earn in an Internet savings account. So my IRR needs to be higher than 5% plus a risk premium. How does one calculate an IRR?
Well the real answer would require knowing with absolute certainty the default rates over time of Propser loan in your portfolio. Prosper data isn’t as old as the term length of the loans, so any default rate would simply be a guess. Since extended credit isn’t available it isn’t possible to isolate the data the same way you can with standing orders. Hence, any suggested default rate is a pure guess.
If I value the principle in the loans at 0 PV. In which case my entire principle $3,361.60 would have been used to generate $20.63 in interest. IRR clearly negative and clearly meaningless. So what is a better assumption?
My Prosper journey is at least 3 years long and hopefully lifelong. So I am going to define an IRR that I think has meaning and follow it over time.
My IRR is the current cash flows (monthly summary of money into prosper and generated by loans in interest payments) with an additional month in which the current account value minus in arrears loan value is used. My current account value according to Prosper is $3,440.16 and I have 0 late loans. Perhaps seeing the data will explain.
My monthly cash flows are
| Month | Interest Earned | Monies Added | Cash flow |
|---|---|---|---|
| 7/06 | $0.00 | ($200.00) | ($200.00) |
| 8/06 | $1.92 | $0.00 | $1.92 |
| 9/06 | $2.33 | ($200.00) | ($197.67) |
| 10/06 | $2.73 | ($1,231.17) | ($1,228.44) |
| 11/06 | $13.65 | ($1,430.43) | ($1,416.78) |
| 12/06 | $0.00 | ($300.00) | ($300.00) |
| 1/07 | $3,440.16 | $0.00 | $3440.16 |
Which generates an IRR of 1.11%. If my money were fully vested at inflow then this would be a pretty bad IRR. But in my experience money takes at least 3 weeks to turn into a loan, the loan takes 1 month to generate it’s first interest. Hence, my IRR has more meaning over time than at any one instant, particularly so early in the journey. I expect my IRR to increase steadily for at least one year and at most 3 years until it levels out. Propser thinks my historical performance is 15.38% for a net gain of $79.25. I fully expect my IRR to be greater than 10%.
I will be keeping this information on a page My Prosper IRR and revisiting over time.
Questions, comments, screams of anguish?
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2 comments ↓
Can you elaborate on what these cash flows are?
I added more detail to the cash flow table which might help, but here is a month by month break down…
07/06 — Initial funding of $200 to my prosper account
08/06 — $1.92 in interest
09/06 — $200 in funds added, $2.33 in interest
10/06 — $1,231.17 in funds added, $2.73 in interest
11/06 — $1,430.43 in funds added, $13.65 in interest
12/06 — $300 in funds added
01/07 — My Prosper account value minus 100% of any delinquent loans
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