P2P lending is an attractive investment as it offers high returns, its easy to diversify and it does not require thousands of euro to get started. However, I see many jumping head-first into P2P lending without taken the proper time to understand P2P lending. Which leads to the question: How much should you invest in P2P lending?
The question you want answered is how much you should invest in P2P lending. There is no right and wrong, but there is some considerations to be had before investing too much in P2P lending.
The right amount you should invest in P2P lending depends on a lot of factors. However, most people should invest between 5%-15% in P2P lending. The factors which influence the P2P lending allocation in your portfolio is risk tolerance, time horizon and diversification wanted.
In this post, I will try to alter your mindset towards what really matters when figuring out how much to invest in P2P lending.
Why You Should Invest In P2P Lending
P2P lending is an interesting investment opportunity. This is mainly because of its higher returns when compared to other investments. So first, I will encourage you to keep an open mind while I go through why it is a good idea to invest in P2P lending.
To put it in plain English: P2P lending is often proclaimed as a risk-free high returning investment, however, that is not 100% true. This is also why it is important to take the time and research how much you should invest in P2P lending, before going all in.
You should invest in P2P lending if you have/or is invested in other assets or is looking for a learning experience within investing. P2P lending should be an asset you are looking at because of interest, not because of the proclaimed returns.
While it yields high returns, there is almost no history on P2P lending. Hence, it is impossible to foresee the long-term effect of investing in P2P lending. I invest with Estateguru and Mintos. Estateguru focuses on real estate development and bridge financing. Whereas Mintos has over 65 different loan originators issuing consumer loans, mortgage loans, car loans, etc.
A TLDR for the following sections: P2P lending is more inclined to be recession-proof, it is a good way to diversify an existing portfolio, and it offers high returns.
P2P Lending Inclined To Be Recession-Proof
There is not much information about the history of P2P lending. However, Zopa, founded in 2005, has been through the financial crisis of 2008. During the financial crisis, Zopa saw average returns of about 6% while the FTSE index was almost -30%.
One thing is for sure, we don’t actually know what happens during a full-blown recession. The P2P lending industry has grown 10X or maybe 100X since the last financial crisis.
What can be said is that due to the claim rights of the loan originator against the borrower, the borrowers can face insolvency and the loan originators can proceed to debt collection.
In the graph from Zopa it is clear that P2P lending is much more effective in a financial crisis. In general, stocks are volatile and P2P lending is a lot more stable.
It is to say that the future looks bright for P2P lending if the loan originators will do a proper due diligence of their borrowers and manage the debt collection professionally, with distribution of the debt to the investors.
However, regardless of an effective debt collection, if a financial crisis hits and the unemployment rates shy-rockets defaults on consumer loans and payday loans will be big.
Now without taking on a Ph.d. in math, I will briefly describe what a correlation matrix is, and what it tells us. A correlation matrix is a statistical model which looks at the linear relationship between many variables. The closer a pairwise correlation is to 1, the more it is correlated. If the pairwise correlation is negative, it means that when one increases the other decreases. You can learn more about correlation matrixes here if you feel the need.
The correlation matrix below shows very little correlation between P2P lending and any other asset.
P2P lending has very little correlation with other assets, hence P2P lending might behave differently in recessions while the stocks, real estate, and bonds will lose value. So while the global stock market, real estate, and bonds is heavily correlated with each other P2P lending might proceed as any other given day.
In times of recession and big market booms, the global stocks tend to fluctuate a lot. Whereas P2P loans are more or less stable in value. P2P lending is stable and only fluctuates with the value of what people sell the loans for on secondary markets.
In essence, the correlation matrix tells us that P2P lending is only affected very little when most other assets are affected.
P2P Lending Is A Way To Diversify
Now to the “No shit Sherlock” moment. P2P lending is a way to diversify your portfolio. It is a stable, more or less predictable income just like dividend stocks just without the fluctuation in value and higher yields.
Looking at the investigation shown below a diversified portfolio will generate a slightly lower return if you hold your entire portfolio throughout the recessions and market booms.
The model clearly indicates that a diversified portfolio does worse in the recovery period of a market crash. However, it also shows that it is less prone to big losses. Furthermore, when holding the diversified portfolio throughout a downturn and the recovery it is only slightly lower returns compared to a concentrated portfolio.
The model distinctly shows that diversification will lower the volatility of your portfolio. If you get a sore tummy from market fluctuation, diversification is surely a good idea.
Where P2P lending has it additional advantages is with the diversification in loan types, currencies, countries and the loans themselves.
On Mintos, there is over 8 loan types and many different currencies. Furthermore, the loans are issued in many different countries. This makes it easy to diversify between loan.
P2P Lending Offers High Returns
Now to the interesting part about P2P lending. The high returns!
P2P lending has become famous for its high returns compared to other asset classes such as stock and bonds.
The popular P2P lending platforms Mintos, EstateGuru, and Grupeer offers returns between 9%-16%. There is also platforms such as Crowdestor that offer returns of up to 34%.
When comparing to other asset classes P2P lending overrules them by far. Only REITs (real estate stocks that are required to pay most of their income as dividends) are in the competitive range of P2P lending.
When looking into the benefits of diversification, it stands out that you should not jump all in P2P lending, or stocks for that matter.
Now I have included my personal returns from the platforms I am currently (or have been) investing with. In the “middle” there is the annual returns as the running return. In the right side of the table is my total returns and total ROI.
My running average annual return is between 8% and 11% by average of all platforms. When looking at the running annual return of my individual platform, it can be seen that Mintos can reach up to 17% in some months.
Knowing The Concept – What Is P2P Lending?
In essence, P2P lending is the same as crowdlending. The crowdlending term is used for business lending, whereas P2P lending is a term used for consumer lending.
P2P lending is short for peer-to-peer lending, and is what the name says: Lending money from peer to peer. This means that if you have money to spare (invest) you can lend your money to other peers.
The other way around, people who need money can go apply for loans and get funded through the lending companies and P2P lending platforms. Examples of P2P lending is Mintos, Swaper, Lendermarket, and PeerBerry.
Another concept is the crowdlending. Crowdlending is the same as P2P lending, however, it is commonly used in business lending. Where crowdlending is different from P2P lending is that people use the word crowdlending in relation to business lending. Examples are Estateguru, Crowdestate, and Crowdestor.
For a full walkthrough of P2P lending and Crowdlending and is advantages and disadvantages you can click here.
How Does The Different Types Of P2P Lending Platforms Work?
There are different types of loans. However, the loans work the same way.
When investing in a loan, you get the claim rights against the borrower for the amount invested. However, there is some distinctive differences between the loan types.
Generally, I see 3 different categories in P2P lending in terms of how they are different.
- Personal loans and payday loans (And other short-term loans)
- Consumer loans (Mortgage, car, credit card, etc.)
- Property investments, business development and improvement loans
With the 4 loan types distinctive “features”, it should not affect how much you should invest in P2P lending, however, it should make you evaluate for the risks in the different loan types.
P2P Lending – Personal Loans And Payday Loans (+Other Short-term Loans)
Personal loans and payday loans are amongst the most common loans throughout the European platforms. When looking at the biggest European P2P lending platform Mintos, 80% of loans issued is either personal loans or short-term loans (~52% personal loans, 28% short-term loans).
Most of the short-term loans are also offered with buyback guarantee from the platform or loan originator.
P2P Lending – Consumer Loans (Mortgage, Car, Credit Card, etc.)
Consumer loans such as mortgage, auto loans, and credit card loans are not often seen within the P2P lending platforms. However, it is possible to lend money for those purposes on the different platforms.
The investor has to be aware of the conditions for the loans. There is not always a buyback guarantee for mortgage and auto loans. Furthermore, most platforms have very limited information about the borrowers.
The limitation of information can make it difficult to evaluate the risk involved with lending money to the specific borrower. This also makes it difficult to answer how much you should invest in P2P lending.
One of the P2P lending platforms that offers mortgage- and car-loans is Mintos. However, throughout Mintos’ portfolio, only 15% is car loans and only less than 1% is mortgage loans. Which illustrates my statement about its popularity.
P2P Lending – Property Investments & Business Development/Improvement
Property investments are different compared to the consumer and short-term loans. Typically the information is richer on platforms issuing properties.
On platforms such as Crowdestate and Estateguru, there is information on the borrowers, the collateral with appraisal reports, contact people (from borrowing company), and detailed walkthrough of the prospect.
The information provided to the investors in the property investments and business developments is a lot better for risk evaluation. It is also t0 be noted that such investments rarely comes with a buyback guarante3e.
However, properties and business loans typically come with collateral protection. The collateral can then do sold to cover the losses. While a buyback guarantee only works if the loan originator has funds to repay the loans, collateral is held in physical assets. Therefore, if a business goes bust all funds are not lost. Some can be gained back from the collateral, such as selling inventory or property.
In other words, collateral is a lot safer if the collateral agent manages the debt collection properly. Whereas, loan originators who suffers financial distress can go bankrupt in trying to hold up to their obligations of the buyback guarantees.
How Much Should You Invest In P2P Lending?
Given the previous information I have provided, how much would you invest?
There is no right and wrong in this instance. It is very personal how much you should invest in P2P lending.
The amount to invest will follow the general advice of how much to invest which relays on risk tolerance, time horizon and the active time used on the investments.
P2P lending is a new asset class with a limited time history. This is an important aspect to consider when deciding the allocation towards P2P lending.
History tends to repeat itself, and if we can see a long-term pattern that the overall returns are stable then it can be considered just as safe as stock picking. However, this information is not available.
The high returns is not secured but there is made incentives to make it safer. The buyback guarantee is not a way to secure your investment. For example, when the loan originator issuing the buyback guarantee comes in financial distress and the expenses is already higher than the revenue, the loan originator will not have funds to repurchase the loans from the investors.
If you are a conservative investor, P2P lending is a bad idea. Due to the lack of historic information, there is no possibility so say whether P2P lending will work in the long-term or not.
Due to the new concept P2P lending has been used to scam just like cryptocurrencies have. Two smaller P2P lending platforms called Envestio and Kuetzal showed out to be scams. Both offered some kind of buyback guarantee or collateral. Sadly, for the investors, none of their money were to be recovered.
Another consideration to have is the time horizon of your investments. If you are young and have plenty of years ahead of you to gather retirement funds, supporting with a couple of P2P lending platforms might be a good idea.
Whereas, if you are close to retirement age, P2P lending could be an unwise idea. A young investor will have a longer time to recover from potential losses or exit for better investments.
In a video done by Fisher Investments shows the difference in risk compared to time-horizon.
When investing for 5 years the average return is between ~5,5% and ~10% depending on the diversification. The risk increases significantly when the portfolio is heavily in equities (stocks). However, if investing for 25 years, the return is between ~5,6% and ~11,2%. The risk is also massively reduced.
This just goes to show that investing long term is a lot more secure. Hence diversification with P2P lending with a long time horizons will most likely also positively impact your portfolio.
Time Management Of P2P Lending
P2P lending is a relatively passive investment. This is due to the auto-invest feature that most P2P lending platforms have. The auto-invest feature enables you to set some customizations to the loans you are willing to invest in.
However, some platforms do not offer auto-invest options. Hence the time used to invest can take significant amounts of time. Furthermore, if the platform does not offer auto-invest features, you are required to manually invest in all the loans.
How Much Do I Have In P2P Lending?
Personally, about 25% of my total portfolio is in P2P lending. That is a very big portion for some. However, my risk tolerance is big, and I am very young.
My experience with P2P lending is that almost everyone should have a small allocation in their portfolio for P2P lending. It is a great way to get some added diversification. Additionally, the returns from P2P lending is hard to find anywhere else.
If you are a skilled stock picker you might be able to outperform P2P lending. However, the model showing the returns between asset classes shows the average investor makes a 1,9% return.
It is, therefore, my perception that everyone could benefit from P2P lending. However, the aggression in the portfolio should reflect your personal time horizon, risk tolerance and diversification wanted.
I have made a risk evaluation for P2P lending platforms. If you want to explore the risk of the different P2P lending platforms (Click here) it is a good start when considering the P2P lending platforms to use.