With any investment we’re taught to diversify to reduce risk and hopefully maximise returns. But most people fail to do this with P2P Lending.
Perhaps they feel that because they are diversified across many loans on their chosen platform, they are safe.
The recent collapse of Peer-to-peer provider Lendy has demonstrated that P2P Lending is not free from risk and you could potentially lose all your money.
As advocates of P2P Lending we feel this is unlikely, and Lendy was a platform that we have not endorsed, but there are some things you can do to minimise this risk.
So, how do you Reduce P2P Lending Risk and Maximise Returns?
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What Happens When a P2P Lending Platform Goes Bust?
Let’s look at the case of Lendy. Lendy was a P2P provider that spectacularly went into administration with lenders now wondering if they will receive anything of their investment back.
In the words of their administrators “a key part of their role is to safeguard the loans made through the company to the various borrowers.”
This sounds moderately positive, but it is unclear what each investor will get back.
As the loans are between the lender and the borrower one would hope they would get the majority back but only time will tell.
How to Stop This Happening To You?
Firstly, you need to consider the returns that the platform is offering. It’s our understanding that Lendy was offering 12%, which is absurd as we’re in an era of record low interest rates.
Contrast that with the more realistic P2P returns of 5-6% that we talk about regularly.
If the lender is receiving 12%, the borrower must be paying even more. These were clearly very high-risk borrowers.
So, RULE #1 – Don’t chase ridiculously high interest rates – if something looks too good to be true then it probably is.
Don’t Invest What You Can’t Afford to Lose
To us this is obvious but time and time again people continuously do this.
We came across a comment on Trustpilot in regard to Lendy, where the person is criticising the lack of warnings and says he can’t afford to lose the money.
We don’t mean to rub salt in his wounds but why has this person invested money he can’t afford to lose in a high-risk investment platform?
We hope that the lesson he learns is not that investing or P2P is bad, but instead:
RULE #2 – Only invest what you can afford to lose.
And RULE #3 – Only invest in what you understand.
Diversification
Every P2P platform we have come across encourages you to invest enough in their platform to ensure you are invested across multiple loans. This is usually at least 50 or 100+ loans.
This is critical, and we suggest you make sure you do this. In our opinion you want your maximum exposure to any one loan to be no more than 2% and ideally much, much lower.
In fact, Funding Circle says they suggest you invest at least £2,000, so you achieve diversification across 200 businesses and have exposure to any one business of less than 0.5%
Diversification Does Not Stop There
What they don’t really tell you and neither will any P2P platform for that matter is that you’re still exposed to the platform itself.
Perhaps your chosen platform is a terrible business and cannot carry out proper risk assessment of loans. The loans that you invest in could potentially all be rubbish.
Therefore, it is also critical to invest across multiple P2P platforms. This way you are spreading your risk.
This is also a fantastic way to boost your returns because the P2P Lending market is very competitive, and they are all offering very generous referral bonuses to obtain new customers.
If you’re interested in taking advantage of such referral bonuses, we have loads listed on our website here where you can earn several hundred pounds in bonuses from very popular (and in our opinion, responsible) P2P platforms. We will be adding lots more over time.
We have also reviewed the platforms and you can find the videos on here and of course on our YouTube channel.
How many platforms you choose to invest across is up to you but a balance between practicality and risk seems like the best approach.
We like the idea of about 5 platforms, but this totally needs to be based on your comfort level. Might as well get the referral bonus from each platform too!
The ISA Problem
A major problem is you can only deposit into 1 Innovative Finance ISA per tax year.
We believe this to a be stupid and dangerous limitation set by the government as it encourages people to under-diversify.
It’s worth noting that if you are basic rate taxpayer you can earn £1,000 before paying tax on interest, so you might not even be concerned about this.
In any case, it’s probably better to go for safety first and use multiple general accounts in addition to using your one ISA.
Better to be safe than sorry. One technique we use is to open a different ISA each year.
Of course, those juicy referral bonuses will help to soften the blow of any potential tax.
New FCA Rules
It goes without saying that you should also have investments across different asset classes.
Well the FCA is placing a limit on investments in P2P agreements for retail customers new to the sector of 10 per cent of investable assets.
It’s difficult to see how this could be enforced in practise. We don’t see how a platform can know other than if you give a declaration what other investments you have.
We understand why the FCA might want to implement this though because P2P Lending looks at first glance to be like saving in a bank, but the risks are very different.
By knowing the risks and how best to protect yourself, you will not go far wrong.
Will you be investing across multiple P2P platforms, to spread risk and take advantage of those sweet bonuses? Let us know in the comments section.
2 Comments
Hi Guys, what are your thoughts on P2P in this current coronavirus position?
I’m currently releasing 10k equity from house to invest in a combo of sipp/isa mainly Vanguard Lifestrategy to add to my regular 800/mth into the same (started investing for first time this month). Tempted by your aggressive strategy and taking a 0% money transfer cc – your bonuses for p2p are tempting but is it too risky now? A number of the platforms are cutting interest to boost their emergency pots to as low as 2% interest, particularly vs 3% cc fee, though it adds extra diversity.
If not a good chunk in p2p where would you invest 10k today?
P.s. thanks for opening my mind to financial freedom!
We just released a video on P2P covid update! Check it out on YouTube. AND we have a video coming out soon on how we would invest £10,000, and another on making money from money transfer credit cards. It’s like you’re reading our minds, man! Ben
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