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Lending Club Discussion => Investors - LC => Topic started by: Deming on July 15, 2014, 06:23:48 PM

Title: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Deming on July 15, 2014, 06:23:48 PM
I'm trying to understand LC NAR, IRR, and my account balance.

Suppose I have an account where I instantly reinvest all paid out principal and interest in new loans.  Assume my Adjusted Net Annualized Return (ANAR) is 17% with Average Age of Portfolio of 6 months.  Over the next 36 months, I continue this strategy of instantly buying new loans with paid out principal and interest until I finally reach an Average Age of Portfolio of 24 months with LC reporting ANAR of 7%.

QUESTIONS:
1. Since I am reinvesting the paid out principal and interest, will it take longer than 18 months to for the Avg Age to go from 6 to 24 months? Is there some rule of thumb for this?
2. Assuming instant reinvesting of principal and interest (no cash drag), would the IRR and ANAR be about the same?
3. Did I earn about 17% for the first 6 months PLUS a declining rate from 17% down to 7% for months 6 thru 36?
4. OR did I only earn about 7% annualized over the entire 36 months?

Thank you for sharing your expertise.  :)

Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: TonySaunders on July 15, 2014, 06:41:07 PM
1. Yes. When you buy new notes the average age of your portfolio decreases. (I don't know the specific formula that LC uses in it's statistics.)
2. If you neglect the time that cash is idle in your account, then IRR and NAR ought to be about the same (ANAR will be slightly different, because it's "adjusted", of course). But that will never happen in practice. Cash is unavoidably idle while you wait for loans to be approved/funded (if nothing else).
3. No.
4. Yes.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: TonySaunders on July 15, 2014, 06:54:07 PM
More accuracy regarding question 2 and 4:

You are basically right... but in this scenario you are reinvesting the interest you earn, so that the interest earns more interest. NAR doesn't account for this compounding interest, but IRR does.

So, you actually will earn MORE than the 7% reported by NAR.

In this scenario (we are neglecting the effect of idle cash on IRR) a 7% NAR at 36 months would be about the same as a 7.5% IRR at 36 months. (An original investment of $1000 would be $1225-ish after 36 months.)
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: TonySaunders on July 15, 2014, 06:58:56 PM
Hmmm... maybe someone should confirm that. I'm pretty sure though.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: AnilG on July 15, 2014, 07:48:19 PM
I doubt you can ever see the Avg age above 18 months for portfolio made of 36 month loans if you are reinvesting the monthly inflow from payments. Recall, every time you reinvest monthly payment, you get new loans that have age of zero. The arithmetic average of zero age loans and 36 month age loans is 18 months.

Simplified:

Average age = (0 + 36) / 2 = 18 months.

Complicated:

For every 36 loans you get approx one new loan every month. This doesn't take into consideration of reinvestment of monthly payment from loans purchased using reinvestment. It shows the maximum limit on average age. Actual average age will be somewhere between 0 and 27 months, most likely about 10 - 18 months.

Average Age = (1 * (0 + 1 + 2 + 3 .... + 35) + 36 * 36) / (36 + 35) = (35(36)/2 + 1296) /71 = (630 + 1296) / 71 = 27 months.

QUESTIONS:
1. Since I am reinvesting the paid out principal and interest, will it take longer than 18 months to for the Avg Age to go from 6 to 24 months? Is there some rule of thumb for this?
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Fred on July 16, 2014, 01:55:22 AM
It is difficult to get IRR to match NAR (much less ANAR), because NAR takes into account late fees, charge offs, and recoveries from every periodic.

NAR formula:
(https://www.lendingclub.com/public/images/10da6d4/obsolete/NAR.png)

To understand NAR behavior, it's probably best to construct a longitudinal analysis (i.e., throughout loan terms) using 2 loans, simulate some late payments, charge-offs & recoveries, and see how NAR changes on each period because of them.

Also, NAR is an "instantaneous" number (to borrow from Calculus class), not an average number for a period of time.  NAR changes every period.  I don't think we can use NAR to answer your questions 3 & 4.

Finally, when you start trading notes in FOLIOfn, your NAR and ANAR will be unreliable because LC uses OutstandingPrincipal, rather than PurchasePrice, for its PrincipalInvested values it the monthly statements.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Fred93 on July 16, 2014, 02:33:39 AM
It is difficult to get IRR to match NAR (much less ANAR), because NAR takes into account late fees, charge offs, and recoveries from every periodic.

It is impossible to get them to match.  NAR is a hack.  It contains no notion of time at all, so it can never properly account for the time value of money.

There is no value in even talking about how stupid it is, except that LC uses it, so people talk about it.  NAR is a hack.

Real men use IRR.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: TonySaunders on July 16, 2014, 11:41:56 AM
It is difficult to get IRR to match NAR (much less ANAR), because NAR takes into account late fees, charge offs, and recoveries from every periodic.

IRR also accounts for these things. If you pay a fee (or whatever) then you no longer include that fee in the value of your account.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: TonySaunders on July 16, 2014, 11:57:35 AM
Also, NAR is an "instantaneous" number (to borrow from Calculus class), not an average number for a period of time.  NAR changes every period.  I don't think we can use NAR to answer your questions 3 & 4.

Yes. Well, kinda. It's an average of all the instantaneous values. In principle, it let's you say "I'm earning a rate of 8.5% at any particular time" even though your actual instantaneous rate might be up/down from minute to minute or month to month.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Deming on July 16, 2014, 01:26:27 PM
Excellent information, thank you everyone.

Now I clearly understand:
1. My IRR and NAR (not exactly the same thing and NAR is a hack) will decrease as my avg portfolio age increases. IRR will be less than NAR.
2. By always reinvesting the principal and interest, the avg portfolio age will be less than the actual time which passes due to adding the new notes of zero months. The expected portfolio max avg age will be about 1/2 of the avg terms of the notes. So about 18 months for 36 month term notes.

So one way of estimating my expected long term NAR is to take the average term of my notes, divide by 2 and then use the LC chart https://www.lendingclub.com/info/statistics-performance.action and find the median point for that avg portfolio age with similar Weighted Avg Interest Rate.

For example, suppose I have all 36 month notes with Weighted Avg Interest Rate of 20%. So, after a long time, like maybe 5 years, my expected NAR would be around 9.4% as taken from the LC chart median value at 18 months. My IRR will be less than the 9.4%, but likely close to it.

Is that a reasonable approach to estimating my expected long term NAR (My IRR will be less than the NAR) ? 
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: TonySaunders on July 16, 2014, 03:12:31 PM
For example, suppose I have all 36 month notes with Weighted Avg Interest Rate of 20%. So, after a long time, like maybe 5 years, my expected NAR would be around 9.4% as taken from the LC chart median value at 18 months. My IRR will be less than the 9.4%, but likely close to it.

Is that a reasonable approach to estimating my expected long term NAR (My IRR will be less than the NAR) ?

Whether NAR is a reasonable metric is totally dependent what you are trying to measure. If you want to know what the long-term return on your investment will be then your current NAR is pretty much the completely wrong tool for the job. That's because it measures the rate you are getting right now on your active notes (with an average age of 18 months or whatever) and not the return you will eventually get on your notes after you've owned them for the full 36 month lifetime.

Hmm... I just went looking for rates of returns on mature notes. It seems like LC is rather fixated on NAR. Which is nice and everything, but as you clearly have learned, it will decrease significantly as notes age, and MOST of LC's notes are quite young (because LC is growing fast).

I guess you could look at the right edge of the NAR graph to get a better idea about the performance of a note after it's full 36 month lifetime. But THAT isn't particularly satisfying data.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: turing on July 16, 2014, 03:44:53 PM
It is impossible to get them to match.  NAR is a hack.  It contains no notion of time at all, so it can never properly account for the time value of money.

There is no value in even talking about how stupid it is, except that LC uses it, so people talk about it.  NAR is a hack.

Real men use IRR.

I agree that NAR is not a good tool for measuring your actual return.  That begs the question, why does LC use NAR instead of IRR?
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: lascott on July 16, 2014, 03:46:27 PM
I guess you could look at the right edge of the NAR graph to get a better idea about the performance of a note after it's full 36 month lifetime. But THAT isn't particularly satisfying data.
That is exactly what I was doing.
(https://forum.lendacademy.com/proxy.php?request=http%3A%2F%2Fi.imgur.com%2FInhMI2v.png&hash=52ccd6feeb1f0ede3fff2fa7dc372c51)
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Deming on July 16, 2014, 04:04:10 PM
Quote
I guess you could look at the right edge of the NAR graph to get a better idea about the performance of a note after it's full 36 month lifetime. But THAT isn't particularly satisfying data.

So are 99% of all LC investors going to end up with a NAR in the range of about 5% to 10% (at right edge of graph) in the end?  IRR will be slightly less than that.   

Does this mean that a strategy like "D-G Top Score" on InterestRadar predicting overall IRR of 13-15% is just a dream?

LC-Advisors offers a fund which has annualized returns of about 8% after accruing for future losses. I guess that is a pretty good return if all of us "do-it yourselfers" are only going to achieve 5-10% in the end anyway?
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Fred on July 16, 2014, 04:37:19 PM
So are 99% of all LC investors going to end up with a NAR in the range of about 5% to 10% (at right edge of graph) in the end? 

Accounts on the right edge of the chart are essentially idle accounts; i.e., no new investments.  Like several people already mentioned in this thread, new investments (even re-investment of payments received) keep your portfolio age low.

Furthermore, if you read LC 10-K, you'll notice that the charge-off rates during 2008-2009 were higher.

(https://forum.lendacademy.com/proxy.php?request=http%3A%2F%2Fwww.sec.gov%2FArchives%2Fedgar%2Fdata%2F1409970%2F000119312514201360%2Fg706350p35.jpg&hash=932476cf6d3a2cb0df4d3175af3c0230)

Perhaps those right-edge accounts gave up on LC, and are transferring their money to somewhere else.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Rob L on July 16, 2014, 05:35:27 PM
Meanwhile "incredadot" (now at 24 months) seems to have been marching day for day to the right since this graph first appeared.
If that's an unhappy camper I'm really missing something here.
Title: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: BruiserB on July 16, 2014, 06:02:13 PM
"Incredadot" - love it! Could this person have bought 500 individual notes of $25 but all from the same loan?  That would be a $12,500 investment and they would technically be separate notes. I have inadvertently bought 2 notes from the same loan before when I was picking manually. I currently have 2 like this in default right now. :-/

I know Bluevestment actually allows you to specifically request $25 notes even if you invest more than that per loan...I suppose to make them more marketable should u later sell on Folio. 


Sent from my iPhone using Tapatalk
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: TonySaunders on July 16, 2014, 06:28:42 PM

Accounts on the right edge of the chart are essentially idle accounts; i.e., no new investments.


The worst of the charge-off rates in the graph above are no longer affecting anyone's NAR. The oldest 3 year notes today are from the second half of 2011 (and that is the BEST year to date).

I don't have any good explanation for the astonishingly consistent and uniform results that seem to be dictated by the right edge of the ANAR graph.  My experience has been completely different from what the graph seems to say. I've been earning about 15.5% IRR and 16.5% ANAR consistently for years, and I know that other people often perform similarly. I'm a good investor, but I'm not such an extraordinary one that I expect to earn double the usual rate. I have no empirical reason to doubt the graph and nothing but anecdotes to contend with it, but I know something isn't right. I think a mistake has been made somewhere in our interpretation or understanding of... something.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Deming on July 16, 2014, 07:25:58 PM
What does LC report your "Average Age of Portfolio" ?
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: TonySaunders on July 16, 2014, 09:46:18 PM
That's a good question. I can't use LC because they say my NAR is 22% because of my use of note trading, so that's totally useless and means nothing.

Instead, I calculate the values myself in a spreadsheet. My IRR calculation is precise. But my NAR is a bit different from LC... I don't track individual notes, after all. Hmm... I retract my statement about my NAR, it's not an appropriate comparison.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: rawraw on July 16, 2014, 10:34:51 PM
That's a good question. I can't use LC because they say my NAR is 22% because of my use of note trading, so that's totally useless and means nothing.

Instead, I calculate the values myself in a spreadsheet. My IRR calculation is precise. But my NAR is a bit different from LC... I don't track individual notes, after all. Hmm... I retract my statement about my NAR, it's not an appropriate comparison.
Hence the big disclaimer on that graph about folio transactions ha ha
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: lascott on July 17, 2014, 03:44:16 AM
So are 99% of all LC investors going to end up with a NAR in the range of about 5% to 10% (at right edge of graph) in the end? 

Accounts on the right edge of the chart are essentially idle accounts; i.e., no new investments.  Like several people already mentioned in this thread, new investments (even re-investment of payments received) keep your portfolio age low.
Good point.  What about folks with 60 month (5 year) notes? How long have those been around? Certainly that will move your average account age farther to the right than those that just buy 36 month (3 year) notes.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Deming on July 17, 2014, 01:53:44 PM
I believe if all cash is reinvested, then you might get lucky with an Avg Portfolio Age of 1/2 the terms of your portfolio.

Average age = (0 + 36) / 2 = 18 months.

In that case, at 18 months on the curve, 80% of us are all looking at a return of between 5.7 and 9.7% NAR. If you hold only 60 month notes, then at 1/2 that term of 30 months, you will be looking at between 5 to 8.8% NAR. That is likely the best case unless the entire curve shifts to the right due to fewer defaults in a stronger economy. It's statistics and there is no escaping the inevitable consequence of an aging portfolio and the curve of despair.

Once you stop reinvesting, your NAR will decrease as your avg age slides to the right and will continue until you are fully liquidated. That will be a sad and painful thing to watch...

Here is a recent quote from a well know LC member whose avg portfolio age is about 15 months old and is exactly where expected on the curve. 

Average Portfolio Description (weighted by remaining principal where noted)
Interest Rate (weighted)
18.1%
Age (unweighted)
456 days
Age (weighted)
359 days

Returns
LendingClub Net Annualized Return
9.70%
Excel XIRR (inc. cash drag)
9.36%

Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Half Right on July 17, 2014, 02:46:53 PM
I was curious so I looked at the age of the portfolio. I have been investing for about 4 years all in 3 year notes. All proceeds reinvested almost immediatly and the average portfolio age is 19.1 months. Apparently the approval process, especially at the end of the month, when LC holds back notes so the Loan Issuance graph looks pretty and consistent, cause the portfolio to age by 3/4 of a month.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Emmanuel on July 17, 2014, 06:40:53 PM
Quote
I guess you could look at the right edge of the NAR graph to get a better idea about the performance of a note after it's full 36 month lifetime. But THAT isn't particularly satisfying data.

So are 99% of all LC investors going to end up with a NAR in the range of about 5% to 10% (at right edge of graph) in the end?  IRR will be slightly less than that. 


6.93%, exactly. Well, at least according to our calculations: http://blog.lendingrobot.com/post/92058702871/ (http://blog.lendingrobot.com/post/92058702871/)
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: turing on July 21, 2014, 12:19:55 PM
What does LC report your "Average Age of Portfolio" ?

I'm assuming you meant to type "where".

Here are some screenshots to show you how to get there and directions.

1) Click 'understanding your returns'
2) See 'Average Age of Portfolio" to left of chart
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Deming on July 21, 2014, 01:09:20 PM
I noticed your account number in your screen shot which you should edit and crop out.  :)
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: turing on July 22, 2014, 12:21:41 PM
I noticed your account number in your screen shot which you should edit and crop out.  :)

Good catch.  Thank you.  I have cropped and reposted.
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: TonySaunders on July 22, 2014, 12:57:08 PM
Ahhh! I can't believe I've never noticed this "Understanding your returns" page before! Here's what mine says, but it's confounded by my use of trading. So not nearly as impressive as it seems.

(https://forum.lendacademy.com/proxy.php?request=http%3A%2F%2Ftonysaunders.net%2Fpics%2Freturns.png&hash=ff36fc1000cad37e8108d8c5b3595f47)
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: Deming on July 22, 2014, 07:03:48 PM
Tony,

What is your actual IRR?  What method do you use for your IRR calculation? (ex. Excel XIRR, InterestRadar).  Does it include cash drag?
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: TonySaunders on July 22, 2014, 11:15:48 PM
Tony,

What is your actual IRR?  What method do you use for your IRR calculation? (ex. Excel XIRR, InterestRadar).  Does it include cash drag?

As of today, my IRR is 14.94%. It's down from 15.5% because I made a big deposit last month and it took a while to get it invested.

Yes, it includes the effect of idle cash, which earns 0% interest. (That's "cash drag" right?)
Title: Re: Help Understanding NAR, IRR when Reinvesting Principal and Interest
Post by: turing on July 23, 2014, 12:11:19 PM
Ahhh! I can't believe I've never noticed this "Understanding your returns" page before! Here's what mine says, but it's confounded by my use of trading. So not nearly as impressive as it seems.

(https://forum.lendacademy.com/proxy.php?request=http%3A%2F%2Ftonysaunders.net%2Fpics%2Freturns.png&hash=ff36fc1000cad37e8108d8c5b3595f47)
It took me a while to find where those benchmark charts were located too :)  I saw people posting screenshots of them, but couldn't find my own.  The link text is not very helpful for where it actually takes you.