“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1,” so said business magnate, investor, and philanthropist Warren Buffet, when asked if he had any golden rules when it came to investment.
And as rules go, we have to admit that those two are pretty good. That looming and understandably frightening threat of losing all of your money is what puts many people off leaving the safety of their idling savings account and putting their cash out to work in a portfolio of investments. Because investing your cash is risky, isn’t it? It’s also stressful and hard, and all sorts of things can go wrong… Those are the thoughts that most people face when contemplating cutting the apron-strings that have been keeping them tethered to the banks for so many years, and there’s an element of truth at their core. Investing is risky, and it can be stressful and hard work. But. If you find the right medium and go about things the right way, you can easily find yourself the proud owner of an independently passive income with minimal risks involved.
Welcome to the wonderful world of P2P (peer to peer) lending.
What is P2P Lending?
P2P is not unlike an online dating service for finance. People looking to borrow funds away from traditional banking pathways list their vital statistics on a lending platform for interested investors to find their perfect match. Relationships are formed, borrowers and investors may both ‘see other people’, then at a mutually agreeable time go their separate ways; the investors usually looking for a fresh borrower for a short-term dalliance.
Of course, it’s not quite as simple as that; when dealing with reputable platforms, such as FastInvest, borrowers have their eligibility assessed by independent financial institutions before their loan request is opened to investors; their credit rating is checked and the likelihood of them being able to meet their monthly payments is evaluated, helping to reduce the risk of lost assets and unhappy investors. In essence, though, it is a similarly symbiotic relationship to that of dating; each partner is looking for a way to improve their fiscal viability; the borrower has need of temporary funds and the lender requires a way to enhance their income. It’s a mutually beneficial relationship.
How Does P2P Lending Compare to Other Forms of Investment?
One of the main features of P2P that appeals to new starters over other forms of investment is that it's easy to start small. With many of the P2P platforms, you can begin your portfolio with minimum funds – with FastInvest you can start for as little as 1 Euro (£0.76) – which means that you can test the water before you jump in. Of course, starting with a single Euro isn’t going to make you rich, or even be a particularly good way to take stock of your potential for return, but it does give you an opportunity to play with the platform; get a feel of what’s involved and see how the system works. And while there is some risk involved, with the possibility of borrowers defaulting on payments, this can be lessened by spreading your investment, and working with a platform which offers a default guarantee (like FastInvest), and stringently assesses all borrowers (also like FastInvest).
The main difference between the risks posed by P2P and the risks posed by other forms of more traditional investment options – shares, bonds, property, or even collectables – is that P2P risks all come directly from the person or people that you are dealing with, while the others are largely created by extraneous variables, such as the general economy and the specific market that you are dealing in. If you put your money into shares, for example, and the company experiences a bad year because they make olive oil and a drought means that there has been a global shortage of olives, or there is a sudden influx of cheaper olive oil from a competitor country, then your return will be minimal. If the drought continues and the company goes bust, then you would lose your investment too.
Another difference with P2P is the duration of the investment. Most P2P loans are for a relatively short-term (1-12 months) and you can see your return trickling in each month as the borrower makes their repayments and you get your proportional share of the whole. If you’re dealing in bonds, shares or property, then it’s more of a long-term process.
How Much Money Can You Make Investing in P2P Loans?
The answer to that question is very much ‘it depends'. It depends on which platform you work with, and it depends on how much risk you're prepared to take. The riskier the proposition a borrower presents, the higher the rate of interest they will deliver, but going hand in hand with that is the fact that they are also more likely to default on payments, thus taking your investment and leaving you with nothing. Of course, you can mitigate this by spreading your investments, so if that one high-risk gamble doesn't pay off, the others should swallow the deficit.
Make sure you pick the right platform too. Typically, FastInvest P2P loan investments come with a 9-13% ROI, although you may occasionally find higher or lower rates on the site. All return rates are listed on each individual loan application however, so you’ll never inadvertently find yourself working at a lower than desired level.
What to Consider When Calculating What You’ll Earn Investing in P2P
As always, there is no one simple way to calculate what an investment will deliver, no matter which form that investment takes, but you can get a fair idea of what you could expect. The first thing you need to look into is your estimated net return.
Net return is important because it will let you know what you've left with once all deductions have been made: your actual gains for your efforts. While this doesn’t make allowances for potential losses through defaulting, it can give you a fair-weather projection. To work out your potential net return do the following equation:
- Take the current value of your assets and add the percentage of stated interest.
- Deduct the original value. Then deduct any stated fees that are likely to be incurred.
- Divide this figure by the original value, then multiply that by 100%.
- That will give you your basic rate of return, but for a genuine return you will also need to factor in the rate of inflation for the investment period – at the moment in the UK that is 2.8% - so take the figure that you reached after the 100% multiplication, and deduct the inflation rate.
This equation will show you what you can expect in the best-case scenario, and with any luck, the best case is all that you need to worry about, but it is worth thinking about where you will be in the worst case, should the borrower default on their payments.
The first piece of advice here is to only invest what you can afford to lose. While no one ever likes losing money, everyone has a threshold of security – be it £20 or £200,000 – so never put in anything which could tip you over the edge.
The second piece of advice is to diversify and spread your investments, that way if one fails you won’t have lost everything.
Thirdly, look at the investment platform’s defaulting policy. FastInvest, for example, offers a default payment guarantee, so if the borrower you've invested in fails to make a payment, Fast Invest will cover that deficit, meaning that you’re never left out of pocket. This isn’t standard practice, however, and the higher the interest on offer by any platform, the higher the risk of defaulting is likely to be. In short, the lesson is: read the small print; you might not like what you find.
Finally, when looking at your potential returns, it’s best to think long term. Or at least, medium term. 18 months is considered to be the peak time to assess whether an investment is working for you. In P2P that generally gives you the chance to have experienced a full lending cycle and to have reinvested your interest for a greater return – if you don’t have the time to do your own asset juggling, the FastInvest AutoInvest tool can help. If, at the end of this period, you work out your net return (do the above equation, minus the first step) and find that you're not much better off, then P2P probably isn't for you. But, if you're like the vast majority of investors, and find yourself better off, then keep going – you’re obviously on the right track.
P2P investment isn’t for everyone. Some people can tolerate greater risks. Some people want faster potential gains. But, if you looking for a relatively safe intro to the world of investments, and you’re prepared to take sensible precautions, then P2P could lead you to the beginning of a passive income.