#TradingSpaces: Is Worthy Bonds Worth Checking Out?

I've launched a new series - #TradingSpaces - in which I share my opinions on various online trading platforms. My goal is to dig into the multitude of investment tools available to investors these days. In this week's Q&A, I give my "two cents" on Worthy Bonds - a no-fee, online seller of bonds that also lends money to small businesses.

Names and personal information are excluded to protect privacy. NOTE: Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.

Q: Do you recommend investing spare change in Worthy Bonds, paying a fixed rate of return of 5%? Can you withdraw your money at any time? Other than being risky, is this investment free of fees?

FYI: Bonds represent a series of fixed interest payments over the life of the bond and then a return of principal to the investor at maturity. To an investor, bonds tend to be relatively less risky than stocks. The upside gain for bonds is fixed, whereas the upside of stocks is limited only by the profitability of the company. On the downside, an investor can lose 100% of his investment with both stocks and bonds…but with bonds, an investor might recover some value from the sale of a failed company’s residual assets.

My Two Cents

Worthy Financial sells bonds (at $10 a pop) that pay investors a flat 5% interest (that’s right, flat…not compound interest) on the amount invested, and then loans the money to small businesses. Unlike bank savings accounts, Worthy Bonds aren’t FDIC-insured; thus, the investor’s total investment capital is at risk. The bonds have a three-year maturity, but they can be cashed out at any time, including interest (much like a savings account). By the way, interest income can be reinvested, which Worthy classifies as compounding…but it isn’t compounding in the true sense of the word.

Pros

Investors pay no fees to Worthy. So how does Worthy make money if it doesn't charge any fees? While Worthy pays 5% interest to investors, it charges more on its loans to businesses and makes money on the spread.

Worthy has a cool feature that allows you to build savings by rounding up purchase you make in your daily life. To start, download the free iPhone or Android app, create an account, and then link your debit or credit card to your account. As you spend, the app will round up each purchase to the nearest dollar (i.e., If you buy lunch at a fast food restaurant for $7.80, Worthy rounds the purchase up to the nearest whole dollar, and applies the 20 cents to your Worthy account). Once your spare change adds up to $10, Worthy will purchase a $10, 5% interest-bearing Worthy Bond. Interest begins accruing within a couple of days of your purchase.

Cons

Although bonds are traditionally less risky than stock, proceeds from Worthy Bonds are used to make loans to small businesses, an exposure that suggests a relatively low return to the investor despite a “higher than normal” risk.

And, although there are no fees paid to Worthy, the bonds are both unrated and uninsured by the FDIC or other insurance agency. This unrated feature creates additional risk even though the bonds are presumably fully asset-backed by borrowers’ inventories. According to Worthy, business inventory can be sold to cover defaults, but if a business has no inventory to sell, well…? It isn't clear what really happens if a business defaults on its loan or what steps Worthy takes to recapture the loan amount. It’s also unclear what happens to investors' principal in the event of a loan default. Presumably, Worthy Peer Capital keeps a reserve fund to cover any loan defaults, further reducing your risk, but is the reserve fund large enough to handle a big default? That’s unclear.

Customer service is average and support appears to be available only for institutional investors or companies seeking financing. In short, with Worthy bonds, you’re on your own in a fairly risky gambit.

In Sum

Worthy offers a good way to develop a savings habit… better yielding certainly than a bank savings account… but more risky due to the absence of FDIC protection and the underlying exposure of loaning money to small businesses. And because of the risk factor, I wouldn’t suggest using it for an emergency fund account.

More information on Worthy is here.