We are always told that the key to a successful investment portfolio is diversification. You should spread your money across geographic regions, industries and asset classes in order to minimise your risk, the idea being if there is a shock in one area your losses are minimised and growth in another area might further reduce your hit.
However, if you are on the hunt for income you may be finding it hard to spread your money across different asset classes and still get a decent yield. The hunt for yield is leading many of us to look at asset classes we may not have considered before, and one of these is peer-to-peer investing.
“One of the dynamics of recent times is the hunt for yield, in an environment when bonds are offering very low levels of income,” says Robert Love, head of research at Asset Intelligence Research. “This dynamic has caused people to invest up the risk scale to provide income and, in some cases, has changed the dynamics of their overall portfolios so that they are taking more risk and so would potentially suffer greater losses in a down market.”
The problem is the traditional investments we all turn to for income – government bonds, savings accounts and top-rated corporate bonds – are all offering very low interest rates. For example, a 10-year UK gilt is yielding just 1.49%. As a result, investors are turning to riskier corporate bonds and other income sources to boost the yield on their investments.
There is an alternative though. Peer-to-peer (P2P) investing is growing in popularity as people turn to it as a way of boosting their income and diversifying their investment portfolio.
“For many years I had been earning a very low rate of return on my cash investments,” says Richard Gill, age 32, from London. “I was attracted to peer-to-peer investments as they seemed to offer a much higher potential rate of return for only a little additional risk.”
P2P investing is where you place your money into an account with a company such as Lending Works, Zopa, Ratesetter, Assetz Capital, Funding Circle or Lendy, the P2P platforms most trusted by Moneywise readers in 2017, and your money is then lent out to small businesses and individuals in need of a loan.
The advertised returns are impressive. Zopa is advertising projected returns of up to 4.6% a year, while Lendy, which offers loans backed by property, has an eye-catching top rate of 12% a year.
“Since investing with Zopa my returns have improved considerably,” says Richard, who works in financial services. “Previously, most of my money was providing an annual return of just over 1%. With Zopa I am now averaging around 5% a year.”
Richard isn’t the only one being lured to peer-to-peer by the returns on offer. The number of people investing in peer-to-peer has surged. Back in 2005 the total lending with Zopa – then the only peer-to-peer lender - was £1.5m; by last year the market had swelled to £3.2bn.
There can be no doubt that the P2P industry has benefitted from almost a decade of low interest rates on cash savings. Many people are prepared to take on the risks of peer-to-peer to quadruple the returns they are getting on their cash savings.
“Those that are diligently putting money away are being short changed by holding their money in close-to-zero return cash accounts,” says Rhydian Lewis, CEO and founder of RateSetter.
“Moving surplus cash into investments like peer-to-peer loans and accepting some risk in exchange for the prospect of better returns, could have added tens of billions of pounds to people’s wallets and purses over the last five years.”
It isn’t just traditional savings accounts that are losing out to peer-to-peer. Some investors are pulling money from other assets and ploughing it into peer-to-peer in order to diversify their income.
Alan Banton, 57, a charity worker from Chorley Wood has an extensive investment portfolio covering traditional stock market investments and buy-to-let properties. He has invested in peer-to-peer for many years as a way of diversifying his portfolio and boosting his portfolio’s income yield.
“Peer-to-peer appeals to me as I like the level of control I can have over my investment,” says Alan. “I do my due diligence and choose carefully who I lend my money to, then sit back and enjoy the rewards.”
Alan’s focus on income-producing investments has proved successful so far. His investment income is sufficient that he only needs to work part-time, and that is in a job he loves.
“I’m lucky, I don’t need to work at all. The money I earn from peer-to-peer forms part of a general investment income that helps with that.”
So, if you want to diversify and invest in peer-to-peer how do you go about it? First, let’s be clear if all your money is in a cash savings account then peer-to-peer is riskier, hence the higher rewards.
Peer-to-peer is largely unregulated, and you are lending money to individuals who may not pay you back. So, there is some risk that you could lose what you put in. But, many peer-to-peer lenders spread your money across numerous loans in order to minimise this risk and some also have a safety fund to cover your losses if a borrower does default.
That said, if you do want to add peer-to-peer to your portfolio you don’t need a lot to make a big difference to your income. Research by Lendy found that someone with 100% of their savings in cash, who moved just 10% into peer-to-peer could see returns of up to 6.2% over two years, compared to 4% if they kept all their money in cash. Lendy even found that, in their example, the person who had put 10% of their money into peer-to-peer would still make a return of 5% over two years even if 10% of their borrowers defaulted.
“For investors who are comfortable with taking just a limited amount of risk, adding a small, diversified peer-to-peer portfolio to their cash savings can be a great way to boost returns substantially,” says a spokesperson for Lendy.