As with any sort of investment, you don’t want to put all your eggs in one basket.
Peer-to-peer lending (P2P) is often promoted as an alternative to the paltry savings rates on offer from banks, as well as a way to protect yourself from the volatility of the stock markets.
However, it should be thought of as a separate way to invest your money and a means of complementing your overall portfolio. I believe it is worth dedicating at least 5-10% of your portfolio to P2P.
P2P lending links individual investors with borrowers.
Investors can fund personal loans, business finance and even bridging, development and buy-to-let mortgages, directly through P2P platforms, without the need for a bank.
The idea is that borrowers get access to finance quicker and investors receive a higher and often inflation-beating rate in return. The downside is that P2P is not protected by the Financial Services Compensation Scheme and there is a risk that a large number of borrowers fail to repay their loans.
P2P platforms are technology-focused and as such their business costs are typically lower than a bank. This economic benefit is passed onto investors as investment returns.
All P2P platforms are regulated and can be checked on the Financial Conduct Authority’s financial services register, and, in many cases, the loans can be held within an Innovative Finance Isa, meaning you won’t have to pay any tax on your returns.
Similar to cash, you will be offered a rate of return, but the risks are very different as loans can fail. If a large number of borrowers default on their commitments you may not get all your money back.
Although the majority of P2P platforms offer early access, the loans can have terms up to five years, so it should be viewed as a mid- to long-term investment.
Ultimately, P2P is a different asset class, which means it won’t follow the wider direction of the stock market as a fund or share would. This makes it a good thing to have in your portfolio, particularly when the stock market is volatile.
P2P investing provides stable and predictable returns that you may not be getting elsewhere.
Inflation is eating into the value of Cash Isas and savings as few rates beat the cost of living. And investing in stocks and shares can be unpredictable, especially amid crises such as Brexit and other political uncertainty.
Meanwhile, last year some of the biggest P2P platforms outperformed the FTSE 100.
The FTSE 100 fell by 12.5% in 2018 – the worst performing year since the 2008 financial crisis. Meanwhile, investors in P2P platforms such as RateSetter and Orca have earned around 5%.
Additionally, as P2P loans aren’t listed on an exchange, there are no wild swings in value that you can get from a shaky confidence in a stock. The value of the loan you invest in is what you get, giving you another element of certainty in your portfolio.
There are of course risks. Borrowers may not pay back their loans and a platform could collapse, meaning you lose some or all of your investment.
But as with any sort of investing, diversification is key across both P2P loans and platforms.
Many platforms will disclose their underwriting criteria and data on both historic and expected loan defaults and bad debts, which helps you decide if you want to invest, but there are also third parties who can conduct much of this important due diligence for you.
Not all P2P investments are the same, just as not every fund works in the same way, Different platforms will have various risks depending on the underwriting criteria and type of loan.
But if done in a diversified manner, P2P lending can help keep your portfolio stable even if other parts are falling.
Iain Niblock is chief executive of peer-to-peer investment aggregator Orca Money