Are you a peer-to-peer (P2P) investor?
If so, you might be wondering how to make the most of your investments. What moves can help you lower risk and potentially boost returns?
If you want to improve your skills, take these peer-to-peer lending tips into consideration before you make your next investment.
What’s P2P Lending?
Quick background for those of you who haven’t heard of this: P2P lending refers to an online marketplace through which ordinary individuals can issue unsecured personal loans to other individuals.
For example, let’s say Joe from down the street has an extra $10,000 that he’d like to invest. He wants an alternative to stocks and real estate, so he looks into becoming a peer-to-peer lender.
Meanwhile, Bob from the other side of the street needs an extra $10,000 to replace his leaking rooftop. He can’t obtain a home equity loan or home equity line of credit from the bank, so instead, he turns to the P2P marketplace.
Two of the biggest P2P companies are Lending Club and Prosper, both of which facilitate these types of transactions.
With that background established, here are top tips for people interested in becoming P2P lenders.
1. Research before you invest
Study the loan history of the lending company you’re thinking about working with. Ask questions such as:
- What percentage of loans fall into default?
- How are borrowers screened and evaluated?
- What average returns have investors produced in the past?
- What’s the process for handling late payments?
Don’t cut corners when studying the track record of company’s investment history.
It’s important to remember that not all lending platforms are the same and they all follow different business practices. Different lending platforms will have different procedures for screening, late payments, and defaults.
Look to investors who have had success with P2P lending and learn from both their mistakes and their triumphs. Use free lending tips on websites such as Lending Academy or Lending Memo to learn from people with practical, everyday experience with P2P lending practices.
Remember, if you feel like you don’t have the answers yet, don’t get started.
2. Start slow
If you’re just getting started with P2P lending as an investment tool, take it slow. Reading and research are great, but there is no better teacher than first-hand experience.
Don’t feel like you need to rush into the market and loan large amounts of money. Take advantage of the opportunity to lend smaller amounts, even $25 per loan. Having a smaller amount invested at the beginning will give you time to understand your lending platform and prevent yourself from making costly mistakes.
If you take too much on too soon, before you really understand the mechanics of P2P lending, you might start to feel overwhelmed.
“P2P lending is not passive. You need to spend time finding new loans to invest in. If you don’t have time, then start small and see if P2P lending is a good fit for you,” suggested Joe Udo, Editor-In-Chief at RetireBy40.org, in a recent article.
3. Know your risk tolerance
Everyone has a risk level they’re comfortable with. You need to know yours before you begin investing.
As with all investments, higher risk usually equals higher reward. Lending to a low-grade borrower will bring in potentially higher yields but greater risk than lending to a high-grade borrower.
“Think carefully about how much risk you are prepared to take, bearing in mind that you could lose the whole of your investment in a loan if it defaults,” wrote Graeme Marshall, CEO of FundingKnight.
4. Diversify your loans
Diversification, diversification, diversification.
If you want to minimize the risk of defaults and protect your investments, aim to hold at least 500 notes. This is easy to do if you invest your money in loans with balances of only $25 to $50 per loan. If your money is diversified across hundreds or thousands of loans, your profits are likely to be higher than your defaults.
5. Reinvest your returns
Don’t necessarily cash out your P2P returns the moment you’re able. Take advantage of the compounding yields by continually reinvesting your returns into new loans.
Alternatively, give yourself a “guaranteed return” by using your P2P returns to repay one of your own debts, like your mortgage or a student loan.
6. Use automation to reinvest
Keeping your principal and interest fully invested is the best way to make the most of your investments. If you have to make a decision about every $25 balance manually, P2P lending won’t be worth your time. Without automation, it’s a hassle to keep every bit of money constantly reinvested.
Make use of automation, and let the lending platforms do the dirty work for you.
7. Keep a strong emergency fund
Before you become a P2P lender, make sure that you have a strong emergency fund that can cover your own personal expenses. You won’t able to withdraw money from the P2P platform at a whim.
Know the game
Investing with P2P lending platforms is a fairly straightforward process, but you need to take reasonable precautions like the ones outlined above.
Follow these tips, keep learning everything you can, and never take on more risk than you know you can handle.
Photo credit: 401kcalculator.org
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