5 reasons to diversify your P2P investments
It’s a fact of life; it is never a wise decision to put all your eggs in one basket. This principle is also a cornerstone of effective investments. One should not “bet” by investing in one single avenue.
If you are putting all of your investment in one avenue, and if returns from that avenue start to decline then you may fall into the red zone with nothing to cushion your fall. Investments into anything other than simple interest bearing instruments come with risks. Before you think ‘why not invest in simple interest bearing instruments’ well, in the world of investments, little risk tends to deliver little return.
How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.
The same principle of diversification should be applied when you are investing in peer-to-peer lending platforms. Let’s delve into five reasons for diversification when investing in peer-to-peer lending.
1. Different platforms, different playgrounds
There are so many different platforms for peer-to-peer lending, but they are not all the same. Each peer-to-peer lending platform, though united on principle, operates differently. For example, Zopa only makes personal loans; Funding Circle makes business loans; RateSetter makes personal and business loans (predominantly) and Wellesley & Co and Landbay fund the property market, but again, very differently.
Even if you choose to invest in just two of the platforms above you have effectively invested money into two different businesses, as both have different lending criterions. You have thus effectively solved the problem of investment singularity; you are not reliant on one type of business.
2. Different platforms, different returns
If you invest your funds forthree years with Landbay they will give you a 3.65% (product dependent) per annum return. Rebuilding Society on the other hand provides returns as high as 17% by letting you choose risker loans to invest in. Assetz Capital offer auto-diversified products and manual selection, so the rates can range from 3.75% — 18% (product dependent).
Diversification allows you to develop an investment strategy suited to your risk appetite, ensuring smooth and reliable returns.
Those with a higher risk appetite can invest greater amounts into higher-risk, higher-return investments while investing small amounts into more stable, but less profitable investments to ensure smooth returns over the terms.
While those with lesser risk appetites can earn less, but more assured returns while investing some funds into higher-risk, higher-return loans to increase the overall per-year yield.
3. Different platforms, different levels of control
Different peer-to-peer lending platforms have different investment strategies. Some like Zopa automatically divide your investments into small loans. You cannot choose who you lend to.
Others have a hybrid system. Funding Circle is one of them. It has an auto-bid tool, which is a feature most peer-to-peer lenders include for simplicity. You can set a criteria and then the tool will bid on the loans and diversify based on that criteria, or you can hand pick the loans you want to invest in.
4. Different platforms, different levels of risk
The no.1 risk in peer-to-peer lending is borrower default. This entails a borrower, who you have lent capital to, failing to pay the monthly debt repayment. This could be a one-off, monthly instalment, or could be the entire loan being unpaid. In any instance, diversification across as many as 100 borrowers should mean your entire investment won’t be drastically affected by a single borrower defaulting. This is one of the main risk mitigation procedures that platforms implement (assuming they offer auto-bid).
Some UK P2P platforms offer a Provision Fund, which is a safeguard pot of money which can be tapped into at the discretion of the platform’s Directors should a borrower default — they may repay you should you qualify for coverage and should the fund be of adequate size. Read our ‘The Provision Fund: how it protects your P2P investments’ here to find out how UK peer-to-peer lenders operate their protective funds.
Also, each P2P platform will differ in their lending criterion, i.e: no platform will lend exactly the same way. Most major platforms will boast a rigid and robust lending criteria, ensuring only the most creditworthy borrowers are chosen. This is all well and good on paper, but unless you manually select your borrowers and conduct your own due diligence you may never know exactly who you’re lending to, how they met the criteria and why they need the loan. Auto-diversifying is a lovely thing for expedience, and it alleviates risk of borrower default, but it doesn’t provide ultimate transparency unless you ask the P2P platform directly.
5. Relying on one P2P Platform, is it a risk?
Nothing is too big to fail. People often view online businesses with rose tinted glasses. Just like you will not put your life savings in one company’s stock, same way you should not bundle all your investments into one avenue. With peer-to-peer investing your capital can be spread (auto-bid) across a varied number of borrowers, but if you have the option of opening multiple accounts with multiple P2P platforms for ultimate diversification, well, wouldn’t you?
Remember money invested is your money, but it is not with you. If a platform goes bust, you should want to know how they plan to pay you back. Peer-to-peer lenders like Wellesley & Co set out insolvency cover and segregate client funds in a separate account, but not all P2P platforms operate in the same vein.
