We all invest for one reason: to make money.
To do this, we need to invest our cash into investment models that are going to make our money work harder by providing the highest possible yield at the lowest possible risk.
Here, we discuss Peer-to-Peer (P2P) lending, the benefits of investing in a diversified P2P portfolio of loans, and how you can go about building one. We’ll also touch upon the risks involved in peer to peer lending to give you a balanced view of this popular new investment approach.
Going back to basics: What does Peer-to-Peer mean?
P2P (peer-to-peer) lending – which comes in a variety of forms – involves individuals lending money to businesses or individuals in need of capital. The money is lent to these borrowers at an agreed interest rate, and it’s the interest on the repayments that generates the yield for P2P investors.
P2P lending companies can facilitate investments in three distinct sectors: consumer lending, business lending and property lending.
On the face of it, this could mean that you, the investor, are placing your money at considerable risk. But if you choose to invest in loans that are secured against physical assets, such as property, you are more likely to receive all or part of your capital back from the sale of the asset should the borrower not be able to repay their loan.
If, however, you choose to invest in unsecured P2P loans, should the borrower default, you will not be able to rely on this as the loans were not secured against an asset. In both instances you should ensure that they have been subjected to a rigorous underwriting process that’s backed by the knowledge of experienced professionals.
Some property P2P lending platforms (such as Octopus Choice) source loans against commercial and Buy to Let properties which have been underwritten by a team of highly experienced property professionals. As Octopus Choice is a discretionary P2P platform, the funds will be deposited across the range of loans on your behalf.
The benefits of a diversified portfolio of P2P loans
As with most investment models, spreading funds across more loans, and taking into consideration a broader range of assets, will undoubtedly reduce the likelihood of a large portion of the investments underperforming. If any loan you are investing in were to underperform, a smaller proportion of your portfolio will be affected.
Let’s look at this way. If you give all your cash to one borrower, and he or she eventually defaults on the loan, you will have lost your entire investment. If you spread your funds across 130 different loans – which, conversationally, is what Octopus aims to achieve for you on average over the course of a year – you’re reducing the risk of non-payment and opening up less of your investment to the prospect of loans going on hold.
There is still a chance that you will lose money, of course. But if you do, this loss will represent a smaller percentage of your portfolio and will not have as much of an impact on your overall yield.
The average loan exposure for Choice investors is 5.7%. This means that, if for example you invested £10,000 into Octopus Choice, on average the maximum amount you will have invested in any given loan will be £570. This is of course just an example, and your maximum exposure in any given loan may vary.
Is it easy to develop a diversified portfolio?
Yes – because many P2P platforms will do all the hard work for you!
If you have chosen a P2P investment provider who will manage your portfolio on your behalf, on a discretionary basis, they will place your funds into a range of available loans. The number of loans your funds are spread across will vary from platform to platform. If you choose to invest with Octopus Choice, for example, a deposit of £600 will be spread across around 60 loans (subject to change and availability).
This will take the hassle out of managing your investments on a day to day basis.
Customers who make regular payments into their account and reinvest their interest may find that their funds are spread across a larger range of loans; as with each new deposit, their fund will be paid into a new group of loans.
As with any investment approach, there are certain peer to peer lending risks.
When you lend via a P2P model, there is always the chance that the people you are lending to will not have the funds to repay their loans, and you will therefore make a loss from that part of your investment.
However, many P2P firms are putting measures in place to tackle this issue. For example, at Octopus Choice, we invest 5% into every loan alongside you, and we make sure we only make a return once our investors have got their money back and earned the expected interest.
P2P loan diversification lessens many of the risks associated with this type of investment vehicle. However, as with any model, your capital remains at risk and instant access isn’t guaranteed.