With Morningstar warning investors in 2016 that they would see an average of 4% annual returns after inflation over the next 10 years, many began to wonder what exactly they should do to look for higher returns.
Enter P2P investing, the new kid on the block promising returns like the good old days.
Thanks largely to the ability to connect with each other directly provided by the internet, P2P investing, an acronym for peer to peer investing, has become a hot opportunity, with many adding it to their overall portfolio and strategy.
Could returns as high as 10% annually be possible using this relatively new method of investing?
What is P2P Investing?
Peer to peer lending is a way for business owners and entrepreneurs to access funding outside of traditional financial institutions. Say for example Jimmy needs to borrow $30,000 to start a coffee shop, but can’t get the loan he needs. He might borrow at least some of the money through P2P lending.
You can get into P2P investing through making loans as if you were the bank. Essentially, you can run your own lending firm from your cell phone or laptop through sites like the Lending Club.
There are two major advantages for you as a P2P investor:
- Shared/Diversified Risk – You will likely be one of many investors making the loan, rather than having all of your capital tied up in one venture. You will also be able to break your capital up and spread it over many small loans, eg by dividing $1,000 into 10 x $100 loans.
- Higher Returns – Loans can be as high as 24%, meaning you can make a serious return. Returns as high as 35% are possible, but the risk outweighs the rewards at that point.
How to Succeed in P2P Investing
Now that you know exactly what it is, here are some tips for success in the P2P lending sphere:
Use a Reputable/Trustworthy Loan Facilitator – Don’t get involved with just any site facilitating P2P loans.
Do your research and pick the right site. In the USA Prosper and The Lending Club are great choices, and in the UK Zopa is the market leader.
Avoid Borrowers with Poor Credit Scores – Each borrower gets a risk assessment score, based on their overall credit score, and it is tempting to go for high-risk borrowers since returns can be 30-35%. Many people fall into the trap of thinking ‘If I spread the risk by investing $1,000 in 10 high-risk ventures, most of them will repay‘.
There is a reason these borrowers are deemed high risk. Most of them will not repay or will default. Resist the temptation and make safer loans, even if returns are lower.
Some people do make some loans to higher risk lenders while making others to medium risk lenders to cover the difference. This is worth considering, but still, poses some risk and you will need to exercise caution.
Consider Borrower History – Many P2P investors tell the all too familiar tale that lending to first-time borrowers, even those with a great credit score, leads to losses much more often than dealing with established borrowers with a record of repayment.
So, consider the lender’s history as well as their credit score. Someone who has successfully repaid loans before will likely do so in the future. Human beings are creatures of habit, and nowhere more so than in our financial lives.
Don’t View P2P Loans in Isolation – P2P investing is no different from any other kind of investing – that meaning the overall economy matters. These are real people in the real world borrowing real money for real businesses, and if the economy crashes, many of them are not going to be able to repay.
Don’t forget about risk management and strategy when investing through P2P programs. Do your homework, assess the risk, form a strategy, then make your decision.
And stay up to date with the news as you would with any other investment you have made.
Make Use of P2P Investment Tools – There are now tools which can help you make better P2P investing decisions. They can screen out risky lenders, look at overall economic trends and stats, and give you a risk score based on various metrics.
Why not make use of the tools available? They are designed to help you succeed.
P2P Investment Summary
P2P investing represents a new, exciting way to invest by directly connecting with borrowers wanting to get started in business.
There are risks, of course, as with any investment opportunity, but with the ability to spread the loans out across many ventures and borrowers, and the ability to choose the level of risk you are comfortable with, there is reason for optimism.
Is P2P investing for you? Giving it a try is always the best way to find out.