Investing in P2P Loans: What Beginners Should Watch Out For

Investing in personal loans, also known as P2P loans as an investment form, has seen an ever-increasing demand from investors in recent years.

To push the discourse on P2P loans further is also particularly interesting because this form of investment can have advantages over classic and rather conservative forms of investment. In the same breath, however, it must also be mentioned that the risks associated with this form of investment are significantly higher and should be considered in a differentiated manner.

What is important, for example, when considering entering the asset class of P2P loans? Based on this question, we have listed a few aspects that private investors should think about in advance.

1. Investment horizon and liquidity

From my point of view, the most important question at the beginning is how long you want to invest your money in P2P loans and how liquid you want to be with your invested capital. Since on some P2P platforms you can invest in consumer loans with a term of five to sometimes eight years, it inherently takes a bit longer for the money to find its way back to you. Late payments or loan defaults can extend the period even further.

Although some providers also offer the option of selling their loan participations on a secondary market, this is usually only accompanied by fees and a discount on the return. Therefore, consider in advance for how long you can do without the invested capital.

The alternative would be to consciously look for P2P platforms with short-term consumer loans, the so-called Payday Loans, where the money is only invested over a few weeks and months.

2. Quality vs. quantity

Broadly diversified, never regretted? Or rather quality instead of quantity? When choosing the right P2P platform, you should pay attention to some criteria. But over how many P2P platforms should you diversify your investment in the end? What makes sense and what is excessive?

First, it depends on how much money you actually have at your disposal and want to invest in P2P loans. Up to 2,000 dollars, limiting yourself to one P2P platform seems to be sufficient. Up to 5,000 dollars, two providers can be useful, and four for up to 10,000 dollars. Take this as a guideline that ultimately always depends on your personal risk tolerance. Depending on the platform, the most important thing is that you can ensure sufficient diversification at the loan level to absorb possible loan defaults (see point 3).

3. Sufficient diversification per P2P platform

As indicated in point 2, it is important to have sufficient capital available per P2P platform for diversification at the lending level. This will help to absorb potential loan losses. Especially for real estate platforms or business loan providers, the minimum investment amount per asset is often between 50 and 100 dollars.

Ideally, for a sufficiently diversified loan portfolio, you should invest in at least 100 assets, which corresponds to a diversification ratio of 1. So, if you are interested in a P2P platform, consider in advance whether you can guarantee sufficient diversification with your investment amount.

4. Track Record

In recent years, many P2P platforms have sprouted from the ground, making it easy to lose track of them all. Especially for this reason it is a good idea to look at the track record and history of the company. This does not guarantee future success in the long run, but in general it makes sense not to invest in platforms with less than two years of market experience. Especially not if there is no coherent background history.

5. Transparency

How transparent is the P2P platform in what it does? Can one find audited annual reports on the website? Can one find out who the people in management and the shareholders behind the company are? Is it possible to create one’s own analyses of the quality of the loan portfolio? Can one gain access to all important documents such as user agreements, entitlements, pledges or guarantees?

The more often the question can be answered with yes, the more transparent the company and the more predictable the risk-reward ratio.

Interesting Related Article: “How to Choose A Peer To Peer Platform