One of the first things you hear about on your investment journey is that you should diversify your investments. Investing into P2P lending is already one way of diversification, as it can be an add-on to your usual portfolio comprised of stocks, bonds, real estate and other assets you may hold.
You can further diversify your investment in P2P lending itself. There’s not just one “P2P lending” but it’s made up of various compartments, each offering you a chance to spread your money. This article shows you all you need to know.
What is P2P lending?
P2P lending comes from the word peer-to-peer lending and initially describes one or many people lending money to another party. Basically, it’s giving a loan on a non-traditional route, the traditional being banks.
Nowadays, the market is more sophisticated and most loans on P2P lending platforms are offered by loan originators. You still invest in the single loans, but more fitting would be to say you invest in the loan originators. This in turn brings some benefits with it, such as a buyback guarantee because if one loan in the loan originator’s portfolio defaults, they can compensate through others as well as any reserves they have.
What diversifying factors exist in P2P lending?
There’s a plethora of differences you can utilize to create a diverse P2P lending portfolio. Some factors have a bigger leverage on the risk management than others.
Different platforms
In the P2P lending landscape, there is a huge variety of different marketplaces and platforms. Two of the well-known ones are Lendermarket and Mintos. Each platform usually brings its features with it, such as:
- Do loan originators offer a buyback guarantee?
- Is there an auto-invest feature?
- Does the platform have a secondary marketplace?
- Are multiple loan types offered (more on that in a bit)?
- How diverse is the pool of loan originators?
Depending on what you need and what you are looking for you can choose your platform. For example, one platform might have a giant pool of possible loan originators, but the auto-invest feature it offers lacks something and a buyback guarantee is not universally available.
Different loan originators
As initially touched upon, loan originators are the companies with loan portfolios, in which you can invest via P2P platforms. As they are companies, you can usually find information about them online, such as how they make their money, past performance and maybe even how their balance sheet looks like.
This enables you to do comprehensive due diligence, allowing you to gauge the likelihood of the company paying back loans and fulfilling their buyback guarantee if they offer one.
If a company has a good track record and a business model where their clients pay high-interest loans, then they can likely pay back loans, even if a percentage of their portfolio defaults.
Different loan types
Most commonly there is a distinction between 3 different loan types in P2P:
- Consumer
- Small and medium business
- Real estate backed
Consumer loans are given out to single individuals. The loan originators typically do some kind of due diligence in regard to the borrower, but the information available is limited. On the other hand, because of that reason, these kinds of loans offer the highest returns.
Sometimes small or medium-sized businesses also work with loan originators to acquire additional funding or cash flow. The information available for a background check is much higher, increasing the likelihood of being able to pay back the money, but lowering the credit rates a bit.
Lastly, you have real estate-backed loans. With these, the borrower needs money and puts their real estate as a collateral. Should they not be able to pay back the money (default), the real estate will become the property of the loan originator and be sold. The loan given out is most often max. 50% of the property value, making this the safest, yet least lucrative option.
Different countries
Loans can come from different loan originators and stem from different countries. You might have loans from Germany, that pay less but in general have a lower default risk, compared to loans from Poland or Spain, with higher interest rates but higher default risk.
Choosing loans from a variety of different countries can also be a good choice to limit your exposure to regional disasters, e.g., if the local economy takes a massive crash, many people lose their jobs and therefore can not pay the monthly rates.
Investing in loans from different countries likely has less impact on the diversity of your portfolio in terms of risk than varying the loan originators or loan types, yet it’s still a sensible measure.
Different Auto-Invest strategies
Finally, you can also utilize the auto-invest feature of platforms to maximize your diversification. For example, on Lendermarket you can specify the minimum and maximum amount to be invested into the same loan. The minimum goes as low as 10 EUR.
By setting this number as small as possible you ensure that your money is divided over the highest number of loans. Therefore, it doesn’t hurt you as much if one loan defaults because you have 99 left to catch you and save your bottom line.
The caveat is that a platform needs to offer a big loan portfolio for this method to bear the best fruits. Because if there are only, say 50 loans to invest in, then you can invest a maximum of 500 EUR before investing into the same loan again. That’s why you need to do a tiny bit of analyzing as well as deciding on your strategy and risk tolerance.
Setup, monitor and adjust
The first step for a diversified portfolio is being aware of your goals and skills: Most likely you want to make the most amount of money but also be able to sleep at night. So think about what kind of person you are.
From that you derive an optimal setup for yourself. How many platforms do you want to invest in, into what loan types and through which loan originators? After that, you set up your auto-invest with a specification that fits your personal risk/reward ratio.
Then you need to wait. Gather data for a year or two and see how your strategy performs. Do your loans default? If yes, on which platform or from which loan originator? How are your returns and are you agitated or relaxed?
Following this, you repeat to adjust your strategy and evaluate again. That way you can build a diversified and robust P2P portfolio that suits your needs and wants, and is always up-to-date.