Is Peer-To-Peer Investing A Smart Move?

Peer-to-peer (P2P) investing is an alternative investment option that has gained traction in recent years. It involves investing money in notes issued by borrowers who seek loans outside of traditional financial institutions. P2P lending platforms facilitate these transactions, connecting individual investors and borrowers. While P2P investing offers several benefits, such as low barriers to entry, monthly income, and higher yields, it also comes with risks, including potential defaults and lack of liquidity. This article will explore the advantages and disadvantages of P2P investing and provide insights into its viability as an investment option.

Low barrier to entry

One of the biggest advantages of peer-to-peer investing is its low barrier to entry. This means that investors can create a P2P portfolio with a minimal amount of capital, making it one of the least costly forms of investing. For example, investors can start investing with as little as $25 on platforms like Kiva and Prosper.

The low barrier to entry in P2P investing is in stark contrast to other industries with high barriers to entry, such as the aviation industry, where massive amounts of time and money are required to enter due to strict regulations and intellectual property protections.

In addition to the low financial barrier, P2P lending also offers a low barrier to entry in terms of accessibility. With the proliferation of the internet, P2P lending platforms have become easily accessible to individuals around the world, providing global opportunities for investing.

Furthermore, P2P lending platforms offer a wide range of loan types, including personal, auto, business, mortgages, refinancing, and medical loans. This diversity of loan types allows investors to choose the types of loans they want to fund, providing flexibility and customization to their investment strategies.

The low barrier to entry in P2P investing makes it an attractive option for individuals looking to invest with a small amount of capital and those seeking to support individuals or small businesses. However, it's important to remember that, as with any investment, there are risks involved, and due diligence is necessary to minimize potential losses.

Monthly income

One of the benefits of investing in P2P loans is the potential for a steady monthly income. P2P investors can receive regular interest payments from the loans they fund, and their principal is returned once the loan term is up. This can provide a solid passive income stream.

P2P lending platforms typically handle the administrative tasks, such as underwriting, loan closing, distributing loans, and collecting monthly payments. They usually deduct a small management fee (around 1%) from the monthly distributions to investors.

The interest rates offered by P2P platforms vary, with some loans having rates as low as 6% and others as high as 36%. A well-balanced portfolio of higher-risk P2P loans can deliver annualised returns of around 10-12%.

It's important to note that P2P lending is not without risk. The default rates for P2P loans can be higher than those in traditional lending, and investors bear the risk of borrower default. Additionally, P2P investments are not FDIC-insured, so there is no reimbursement if the borrower defaults or the platform fails.

To maximise monthly income from P2P lending, investors should consider diversifying their portfolio by investing in multiple loans and borrowers. This reduces the risk associated with any single borrower defaulting. Some platforms also allow investors to choose between funding entire loans or investing in smaller pieces of multiple loans (notes), with amounts as low as $25.

While P2P lending can provide a monthly income, it may not be wise to rely solely on this as the income stream can be irregular. It is recommended to pair it with another steady income source. Additionally, a large upfront investment may be required to generate a substantial monthly income.

For example, to receive a monthly income of 250€, an investment of at least 20,000€ in a P2P account may be needed. The required investment amount will depend on the interest rate and the desired monthly income.

In summary, P2P lending can be a great way to boost monthly income, but it comes with risks and considerations that investors should carefully evaluate before committing their capital.

Higher yields

One of the main advantages of peer-to-peer lending for investors is the potential for higher yields. A carefully curated portfolio of loans can potentially earn 10% annually or better.

The higher yields are made possible by cutting out the bank middleman, allowing investors to pocket more of the interest paid by borrowers. Peer-to-peer lending platforms also have lower operating costs than traditional banks, which means they can offer higher interest rates to investors.

Additionally, peer-to-peer lending platforms use proprietary credit evaluation algorithms that can look beyond FICO scores to determine a borrower's creditworthiness. This enables more people and businesses to get funding, which can lead to higher yields for investors.

It's important to note that higher yields come with higher risks. Most peer-to-peer loans are unsecured, which means there is no collateral backing them. As with any investment, it's crucial to carefully evaluate the risks and diversify your portfolio to minimize potential losses.

No location limits

One of the key benefits of peer-to-peer (P2P) investing is that it offers investors access to the best and most attractive investment opportunities anywhere in the world, regardless of their location. Due to their digital nature, P2P investments are not limited by geography, allowing investors to tap into emerging markets with higher returns.

For example, P2P loans in Germany may offer returns of 5-7%, while those in Eastern Europe often exceed 10%. This geographic diversity not only provides access to higher returns but also helps increase the security of an investment portfolio by safeguarding against regional financial crises.

The lack of location limits in P2P investing means that investors are not restricted to their local markets and can instead seek out the most profitable opportunities globally. This feature of P2P investing is particularly advantageous in the context of the COVID-19 outbreak, which has led to volatile markets and a need for different asset classes.

P2P investing platforms, such as Kiva, Prosper, and Upstart, facilitate this global investment opportunity by connecting investors and borrowers from diverse locations. These platforms often employ proprietary credit evaluation algorithms to assess borrower creditworthiness, enabling a wider range of individuals and businesses to obtain funding.

In summary, the absence of location limits in P2P investing empowers investors to access a broader range of investment opportunities, diversify their portfolios geographically, and seek higher returns in emerging markets, all while remaining location-independent.

Better returns

One of the main advantages of peer-to-peer lending for investors is the potential for higher returns than are available from a savings account or other investment types.

The average rate of return for the stock market has been around 10% for the last century. However, for loans issued by LendingClub from 2015 to 2018, the median rate of return ranged from 4.7% to 10.3% for creditworthy borrowers, according to the International Review of Economics and Finance. Prosper puts its average historical return at 5.7%. Some investors report average annual returns of more than 10%.

The higher returns from P2P lending are possible because the platforms' proprietary credit evaluation algorithms can look beyond FICO scores to determine a borrower's creditworthiness, enabling more people and businesses to get funding. By cutting out the bank middleman, P2P lending allows investors to pocket more of the interest paid by borrowers.

However, it's important to remember that with higher returns comes higher risk. Most P2P lending platforms vet borrowers, but it's always possible to lose money if a borrower defaults. As with most high-return investments, gains are never guaranteed.

Frequently asked questions