My dream is to invest without risk
Unfortunately investing is never 100% safe
Peer to Peer Lending is anything but safe
(..you wish🌶it was)
..but it can be transparent
Let’s find out if investing in P2P loans is safer than other forms of investment and if P2P lending is safe or not
⚠️ Warning: I’m going to get in trouble writing this article because safety (and risk) of P2P lending is not very comparable to other forms of investment.
Investment risk among different asset classes is not easily comparable in general.
But I’ll do it anyway because I am a do-it-yourself investor (so I want to know) and because …I like both oranges and apples…so, let’s compare it!
We need a starting point, so let’s check the Investment Risk Pyramid by the authoritative Investopedia website:
Of course other factors come into play like:
- Time horizon
- Risk tolerance
Real estate and mutual funds are in the middle of the pyramid.
Cash, savings and bonds are in the low-risk area (from a US investor point of view).
What else is missing?
As you can see, Forex and Binary options are missing since those are not even considered investments.
Is P2P Lending safer than real estate
Real estate investing Vs. P2P lending
I am happy to answer “it depends”, and by doing so, I am sure I got all your attention…
How can solid real estate be riskier than loans?
…you must be joking…
I’m not. Follow me…
I will give you an example of how easy can be to make a huge mistake by investing in properties if that is the only or the biggest move of our life.
Let’s suppose I am a D-I-Y investor with limited but growing investing power in Europe.
Also, my knowledge of real estate investing is limited. Not to talk of the limited time I can spare to search for the right deal or to go to some estate auction.
It is 2020, and I want to buy a house to rent it out in my town and generate cash flow.
…just the way Kiyosaki did in Hawaii in his “Cashflow quadrants” book.
Property prices in most big towns are expensive, so I need a loan to start to invest.
The common real estate problem is here: I need debt to invest what I have. Leverage. Am I trained to use leverage?
Unfortunately, the chance I get the right property in the right place and make a positive deal is very low for a number of reasons.
So I think that if I start investing in real estate this way, with a down payment that is less than 30% of the property price, I am extremely likely to get stuck in that very first bad deal forever.
I will end up with a liability rather than a passive income and my future investing power will be limited for ages.
Doing so I am putting all eggs in the “real estate basket”, and it is not wise.
Real estate investment returns are not as high as one can imagine, and property prices are, by no means, stable nor constantly rising.Real estate investing can limit my diversification and thus augment my portfolio risk Click To Tweet
Are P2P loans safer than mutual funds
Mutual funds and ETFs Vs. P2P lending
Not safer but just different.
Returns are similar for now.
Let’s find out more…
US investors are very used to invest in mutual funds in the US market.
US markets are, on average, the best performing ever, at least this was true in the last 100 years.
On average, the SP500 generated approximately some 8% return to its “buy & hold” long term investors.
This is to say that if you invested in passive low cost US funds, you may have had a very nice and stable performance so far.
European investors investing in European markets cannot say the same if they have invested in their home markets.
On the other hand, P2P lending in the US is less lucrative than before, and possibly the same will happen in Europe in the next years.
What is better? Investing in P2P loans or investing in US mutual funds in UDS?
To be successful, I need both.
Is P2P lending safer than savings accounts
Savings accounts Vs. P2P lending
No, social lending cannot be considered safer than savings accounts, at least in Europe, UK and USA.
Is peer to peer lending covered by FSCS or DGS?
Peer-to-peer lending sites in the UK are regulated Financial Conduct Authority (FCA).
So, savings accounts are safer than P2P lending.
But, there is a but…
…don’t call it “investment”.
Savings accounts may not even be considered an investment tool nowadays.
European investors in most cases are losing money left cash on their savings account.
Every year inflation, costs and taxes eat out a part of the spending power of those euros left sleeping in the bank.
What do I want to say?
If they tell you to invest in something that is going to lose value steadily over the years, what would you do?
Most zero-point-nothing interest savings accounts are making investors lose money.How safe is an investment with a steady negative outcome? Click To Tweet
Food for thought ..and for comments below.
Every euro I leave on my bank account is losing value over time.
Every euro I invested in loans in the last years has been producing me revenue.
Since I don’t like to lose money and “past performance is no guarantee of future results”, I need both, and I am happy.
Is P2P lending safer than cash
Cash Vs. P2P lending
I find it normal to always keep something in cash and immediately accessible on my bank account.
What I didn’t know was that what is normal for me, can be a nightmare for others.
I’ve found out that many people are not able to keep some money available and not to spend it right away.
In the US is very often like that, and also in the UK people just spend all the money they have at reach, so they need to have invested money on separate accounts somewhere else.
So, it is not so easy for anyone to keep liquidity available.
The latest evolution of some European P2P lending marketplaces is to give the investor the chance to cash out the investment immediately.
This tendency of mixing invested money and savings can be very bad for many.
Also, the perceived risk is misleading. Investing in “Invest & access” and Bondora Go & Grow has nothing to do with the safety of having cash available on my bank account.
The verdict: Cash is (normally) much safer than social lending.
Is P2P lending safer than TOL (Online Trading)
P2P Lending Vs. Online Trading
Investing in individual shares has been a passion for me. It still is.
Today I know that I don’t want to live off the profits generated by my trading activities because … I care about my mental health.
TOL is fun but nevertheless dangerous from an investing point of view.
Building a long term high-yield portfolio can be (on average) much safer than P2P lending.
On the other hand investing in loans is much “easier” than building a high-yield portfolio, if starting from zero knowledge.
Is P2P lending safer than doing nothing
Inaction in investments has a cost.
I will never be tired enough of repeating it.
I’ve lost money over the years, doing nothing but waiting for the right investment, just because I didn’t know how to invest properly.
Going to the bank asking to invest was a total disappointment, so I gave up.
I have chosen to learn and invest D-I-Y with profit and to find out by myself what are the best peer to peer websites in Europe and what is the best way to diversify my assets.
Peer to peer loans cannot be the only asset class in a portfolio. That would be insane.
Risk/reward ratio in P2P lending ⚖️
For me, crowdlending investing can have a high risk/reward ratio.
Good knowledge of the platforms and of their automations is giving me nice results.
In addition to this, I also consider that with the recent one-click auto invest settings offered by some bigger platforms, the time needed to manage the loans portfolio is minimal to zero.
The low-maintenance of P2P investing is making the “reward” factor even bigger from my point of view.
In general, I think that the highest rated loans still offer a good balance between default rate and paid interest.
Why is the perceived risk of P2P loans lower than usual nowadays?
We are in a prolonged low interest rate era.
We forgot what “normality” is and there are only risky alternatives around.
Investors, funds and just anyone is desperately searching for some fairly priced investments, but there aren’t.
I believe many bonds are not fairly priced lately, and bonds were the “safer alternative” in the past.
This is also a hard time to start with a bond laddering strategy.
Comparing P2P platforms is the best way to make an informed decision if one is ready to add loans in a portfolio.
P2P lending Vs. P2B lending loans
In the last few years a few platforms offering extremely high interest loans arrived in Europe.
(These p2B platforms have nothing to do with the ordinary P2P lending loans like Mintos, Twino, Bondora, Peerberry).
I always wondered if their business model was sustainable. What I am mostly worried about is that they are offering investors to exit the 95% of their loans just anytime. This is sustainable if they have a large provision fund and I believe to know the haven’t any. How can they buyback 95% of all loans? Easy, they should have huge cash reserve.
While I am updating this article two P2B platforms offering risky loans in euros are having problems. This problems have nothing to do with the two bigger UK platforms that suspended operation last year.
In 2017 I received an email from Envesio CCO that asked me to review his newly born platform. i make clear he was not offering me any advantage as investor or author. I’ve never answered to that email but I kept studying Envestio for months. I ended up to write the worst Envestio (bad) review ever written in march 2019. I am still convinced of what is in that post and I am sure that read helped thousand of investors not to invest or reduce exposition to Envestio. It still is one of the most read content of this blog.
I think P2P lending is great for me because it lowered my overall portfolio volatility and I haven’t lost a cent so far. I also know that I’s better not invest in loans more than 20% of my portfolio for now. If one day I’d feel like making a small test in P2B loans I’d have to look for the right tool (Flender is my pick for now but still small).
P2B loans are much riskier than P2P loans. Very high returns offered may be an indicator of the risk involved.
Crowdlending can add diversification
The most obvious deduction:
Anytime I add an asset class to my portfolio I am lowering the exposure to all other classes of investments.
Even if the asset class I am adding is a risky one, this doesn’t change.
Adding a risky asset class to a balanced portfolio is good for performance and safety.
Risk seen from 3 points of view
Lenders, Platforms and investors have very different problems to solve.
- Risk from a Lender point of view can be whether a borrower pays the loan on time.
- Risk from a marketplace platform view (e.g. Mintos or Peerberry) can be whether the selected lenders keep afloat and transfer money to customers regularly (but also to provide enough quality loans to investors and enough investors to the lenders).
- Risk from an investors point of view can be whether the loans are repaid regularly, the buyback schemes are applied (if provided), and interest on late loans are paid (if provided).
The credit scoring model used by lenders is normally inspired to the logistic regression.
Non-Linear Neural Networks, are used to lending data in order to predict the likelihood of default of issued loans.
The risk measurement model used by marketplace platforms is not disclosed.
The risk measurement model used by investors approaching P2P investing …depends on who the investor is.
From what I see, only a few investors are willing to access the right data and find out how safe is a P2P platform and/or its loans. Many just go for the highest (promised) ROI, or for the shortest loans (…which is pointless).
Platform Risk in P2P Lending
I know today that it is wise to spread resources over more loans, in more countries using more tools.
P2P lending platforms are basically of two types:
- Bondora or NeoFinance for example, sell and split up their loans
- Viventor or Mintos for example, manage loans from other credit agencies (lenders)
If a platform sinks it is a problem for me as an investor, but in the case of Mintos and Viventor it may be less serious. Actually, they are only intermediaries and their finances are (always?) separated from the loans.
This affirmation can be limited in some cases. Mintos seems to be rather connected to Mogo, Hipocredit and two other loan originators.
The risks associated with investing in loans should be well understood before starting, and it makes sense not to invest more than I would be willing to lose.
A distinction must be made between investment in loans and investment in equity crowdfunding. The latter is riskier than P2P.
P2P during a crisis
P2P Lending is a rapidly evolving and expanding sector and it has (almost) never gone through a serious economic downturn during its short life.
The real P2P lending resilience test will take place with the next crisis.
The next financial crash has been announced repeatedly in the last 10 years.
Truth is: We are in the longest bull market ever, economy is exploding, our lives are safe and comfortable but instead of riding it and enjoying it… we waste time reading the news announcing the next tragedy.
The economy will slow down sooner or later, as it alway happen cyclically, and again “this time will not be different“.
Let’s be honest, it will not be easy, especially for the lowest-rated loans and the most fragile lenders.
In a growing or stable economy, things look nice. Social lending these days almost looks like fixed income to some. Big mistake.
The most dangerous business loans are likely to be the first to suffer.
If large portions of the population will lose their job the lowest-rated personal loans will be involved. Most of the low rated loans are given to borrowers with a high debt-to-income ratio and they won’t be able to repay the debt.
In 2008 there was Zopa P2P in the UK, but not the P2P Lending as we know it today, so it is difficult to make meaningful comparisons.
By the way, Zopa did quite well in 2007/2010, but past performance are not… bla bla bla.
Now it’s your turn!
What do you think?
How safe you feel?
Write it in your comments and share this article!