As you all know if you are a regular reader, I am a fan of Lending Club. Lenders on the site are exposed to the entire dynamics of a market system, and that correlates directly to what you experience when investing in the stock market. If you are not familiar with the site, I will start with a quick breakdown of how it works.
When you sign up with Lending Club, you are given the ability to invest in personal loans to other people in $25 increments. If you sign up through links from this website, you are given a risk free $25 bonus to begin investing. The loans are listed by a credit rating system developed by Lending Club. Higher risk loans have a lower rating. As the risk level increases, so does the interest rate.
What does this teach you about the stock market? Higher risk should equal higher return, but high risk means a higher chance of losing all or part of your investment.
This is what investment analysts, insurers, credit issuers, and individuals look at when deciding how to invest and what return is expected. If you invest in a stable blue chip company like Walmart, the risk is low and the stock return will be relatively low. If you invest in a start-up tech company, there is a good chance it will fail and you will have a loss. However, there is also a chance that the company will be wildly successful and you will have a several hundred percent return.
Lending Club is a great way to get a feel for what you should be thinking when investing. Many people buy and sell stocks based on emotion and news. This is a bad strategy, because it does not take the intrinsic value of the company into account. The intrinsic value includes risk, and higher risk should correlate to a higher return.
A recent example of this can be seen in by looking at two companies: AIG and Lehman Brothers. Around the same time, these two companies appeared to be on the brink of bankruptcy and possible closure. Had you invested $100 in Lehman Brothers in mid 2008 as the financial crisis began unfolding, you would have nothing today. Shortly after Lehman's bankruptcy, there was an opportunity to purchase AIG for less than $10 per share. Many people speculated that the company would fail. That $100 investment would be worth about $400 today. That is an example of high risk for high return.
In the same time period, you could have purchased Walmart with little worry about its future. That $100 would be worth about $114 today. That is still a good return, but not nearly 300% that you would have earned had you made a risky bet in AIG.
The same is true at Lending Club. You can buy into an A rated loan for a 7.14% return or a G rated loan for a 20.90% return. Higher risk means high possible return, but a higher chance of default comes along with it.
If you decide to start investing with Lending Club, please consider signing up through an affiliate link from this site to support my efforts at Narrow Bridge Finance.