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Here’s How You Can Manage Your Investments Risks In Peer-To-Peer Lending With Diversification

One of the largest risks in investing in a Peer-to-Peer lending platform like Funding Societies is the risk of a loan defaulting. For business term loans, a default is defined as a loan that has been unpaid for over 90 days. For invoice financing, a default is defined as a loan that has been unpaid for over 60 days.

To manage the default risk, investors should consider diversifying their portfolios.

What is diversification?

In investing, diversification refers to investing in multiple assets to reduce the risk of the portfolio. In the context of Peer-to-Peer investments, diversification refers to investing in multiple loan products.

Don’t put all your eggs in one basketWARREN BUFFETT

Invest in each and every loan

By investing the minimal amount into each and every loan opportunity offered, your risk is reduced. In the case where a loan was to default, the principal amount lost would not impact the entire portfolio heavily.

How Does Diversification Work?

Illustration:
If an investor were to invest $5000 into a single loan at 12% per annum with a tenor of 1 year, he would expect to earn $600 in interest.
Total Interest Earned = 0.12 × $5000 = $600

However, in the unfortunate case that this single loan was to default, his total loss would be $5000, with a rate of return of -100%.
Rate of Return = -$5000 / $5000 = – 100%

If the same investor were to invest $100 into 50 loans each at a 12% per annum with a tenor of 1 year, he would invest a total of $5000 and also expect to earn $600 in interest.
Total Interest Expected = 0.12 × $5000 = $600


Assuming a 2% default rate, (which means that out of the 50 loans, 1 loan defaults) the investor would earn interest on the remaining 49 loans.
Total Interest Earned = 49 × $100 × 0.12 = $588 

The investor loses $100 from the default. The investors return on investment would therefore be:
Return on Investment = $588 – $100 = $488

The rate of return, in this case, would then be:
Rate of Return = $488 / $5000= 9.76%

Higher amount into lower yield and lower amount into higher yield

Depending on the risk appetite of the investor, some investors may prefer to invest more into lower yield loans as they are assessed to be stronger borrowers and smaller amounts into the higher yield loans.

A typical borrower could be charged between 8% – 11% p.a. in simple interest, while the ones assessed to have higher credit risk may pay interest at a higher bracket, between 12% – 16% p.a.

Illustration:
An investor invests $1,000 into 3 loans at average 9% p.a. and $100 into 20 loans at average 14% p.a.
The investor obtains $270 from the lower yield loans and $280 from the higher yield loans for a total portfolio gross return of $550. Assuming a 3% default on principal, your portfolio would still yield $400 in gross returns.

How To Manage Your Investment Portfolio Like A Pro

Managing an investment portfolio is a lot like managing a business. With a disciplined, patient, and proactive approach, you can preserve and protect your wealth while attaining financial independence. Your investment strategies might differ, but you’ve to begin with some principles that are consistent at its core, which not only match the markets but your individual characteristics as well.

It’s also important to remember that not all investments in a portfolio may generate returns. It’s a lot like a badminton match – you will lose some points, but to win a game you’ll just have to win more points than you lose. Read the following keys to investing and know how you can ace those points!

Invest only in assets you understand

In many cases, retail investors take action in the fear of missing out on a “sure-shot” investment opportunity. The key is to avoid any frantic decision. Don’t worry about what you don’t know, worry about being sure on what you do know. If you don’t know how an investment actually works, you can’t know whether you really need it. There are plenty of alternative investment opportunities like P2P lending, which are easy to understand and implement. Consider investing in those.

Diversify

It is a prudent approach to create a basket of investments that provide broad exposure within asset classes. It spreads the risk and reward within your investment portfolio. When it comes to investing, the more diversified you are, the better.

We also advise diversification within an asset class or sector. For example, if you invest in P2P lending, you can distribute your investments across as many SMEs as possible to prevent loss in case an SME defaults. Even defaults hardly disturb your rate of return.

If you’re investing in stocks, make sure to not put more than 4% of your total portfolio in one individual stock. This will ensure that if a stock or two faces a downslide, your entire portfolio doesn’t suffer.

Invest for the long term

We believe that a long term horizon is a necessary ingredient for investment portfolio success. Investing is a marathon, not a sprint. Don’t get carried away with the ebb and flow of the market, and stay patiently invested. Also keep in mind that past performances are no guarantee of the future, and individual situations may vary.

Rebalance your portfolio regularly

Over time, your investments may fall out of sync with the original asset allocation. You may also want to restructure investment allocation. Re-assess your portfolio every six months or annually. Try not to tinker with your investment portfolio at short intervals of time – it’s also important to give time to investments.


This article was written by Funding Societies, Singapore’s leading peer-to-peer (P2P) lending platform. They provide working capital loans for small and medium-sized enterprises (SMEs), along with attractive investment opportunities to the broader public. 

Funding Societies is a DollarsAndSense Brand Connect partner. If you are interested to know them better, you can find out more on what they do on our DollarsAndSense Brand Connect Page.

Default Rates in Peer-to-Peer Lending Platforms

To paraphrase Crowdfund Insider’s “The Ultimate Crowdfunding Guide,” with peer-to-peer (P2P) lending, the risk an investor accepts is default. Every P2P lending platform has its own policy on default, and all investors need to take the time to understand these policies in order to protect themselves.

Because every P2P platform has its own default policy, and because the P2P lending business model is relatively young, we must be cautious when making generalizations about default rates across all platforms. Specific to Funding Societies, we fully aim to keep default rates close to banks – not exceeding 4 to 5% of loan amount to secure healthy returns for investors, even accounting for the cost of default.

The industry’s youth may cause investors with low-risk tolerance to view P2P lending as an unpredictable instrument. Generally, there is a consensus among investors that P2P lending constitutes a higher-risk, but higher-reward investment.

Is this belief true and valid? Let’s take a look at the global trend of default rates in P2P lending platforms.

Default Rates on P2P platforms in the USa

Let’s begin with default rates in USA platforms. In this fascinating article, the author analysed historical trends of default in two well-known USA platforms, then drew conclusions about the default rate of the P2P industry.

(Note that the article was published in 2014, so some might find it dated. However, the analysis within is worth a read)

The writer pointed out that from 2007 to 2008, the USA economy was doing very poorly and that both Lending Club and Prosper were operating under their earliest and most imperfect credit models, which means the default rates of 2007 and 2008 can be waved off. Since 2010, both platforms have averaged a 5% default rate and are likely to continue having solid repayment rates in the future.

The article ends with a positive conclusion about the P2P lending industry. The author wrote: “I see refined underwriting algorithms and mailed borrower marketing, encouraged investor capital and purpose-built technology all repositioning itself over and over for the past eight years until they are arrive at the stable place they hold today. I see analysis and sweat and reanalysis in these charts, and in the end I see it culminating into one of the most simple and creative investments our country has ever seen.”

His statement underscores that under the right circumstances, which includes an innovative team and rigorous credit policies, P2P lending platforms thrive and provide attractive returns while lowering default rates. The key is in selecting a trustworthy platform to invest in.

Read More: 5 Reasons To Invest in Peer-To-Peer Lending

DEFAULT RATES ON P2P PLATFORMS IN THE Uk

Moving on, let’s focus on a well-known and respected P2P lending platform from the UK: Funding Circle. In their statistics page, Funding Circle claims that its average annual default rate stands at 2%. The rate has also remained solid over the years (calculated from 2012-2017), showing that platform maturity and good credit underwriting will stabilise default rates.

funding societies’ DEFAULT RATES

What about our own platform, Funding Societies? Here is our own statistics page. Historically, our default rate across the region has lowered overtime, which reflects the analysis of P2P lending platforms in the USA: continuous platform improvement and rigorous credit policies will lower default rates.

Another worthwhile read about the risks in P2P lending is the study released by the UK Peer-to-Peer Finance Association (P2PFA). Some of the study’s pertinent points include:

  • The P2P industry has created more choice in the financing and investment market.
  • P2P lending platforms conduct credit risk assessment using the financial industry’s best practices.
  • P2P lending does not create systemic risk. Platforms are well-placed to weather a downturn in the credit cycle – defaults would need to increase at least threefold to reduce average interest rates for investors to below zero.

So let’s go back to the question we asked earlier: is P2P lending a higher-risk investment? Not necessarily.

However, the P2PFA study presented two caveats: that there is a good regulatory framework for the P2P industry and that investors are educated. For the first point, MAS has begun setting up regulations for P2P lending platforms. Funding Societies has always been compliant with regulations; we hold the CMS license required by MAS to operate, along with taking due diligence and our credit assessment process very seriously.

For the second point, there will always be risks in investing, including risk of default in P2P financing. But there are ways to mitigate such risks.

Read More: Investing In An Uncertain World

how can i diminish p2p investment risks?

How do you diminish P2P investment risks? You diversify your investment and reinvest your returns.

Diversification means distributing your funds across as many investment opportunities as possible to prevent loss in case of default. The more diversified you are, the more protected your investment. Even defaults hardly disturb your rate of return. If you choose not to diversify, you stand to lose most of your investments should a default occur.

Meanwhile, reinvestment refers to the act of funnelling your investment gains into new investment opportunities to maximise your returns. Without reinvestment, you only receive the expected rate of returns. But with reinvestment, you can maximise (sometimes doubling, even tripling) your returns while minimising your investment risks in case of default.

For more information on diversification and reinvestment, see here.

When investors fully understand the risks of P2P lending and take proper precautions to protect their funds, the advantages of investing in P2P lending clearly outweighs the risks. In fact, it’s very likely that most investors who keep diversifying and reinvesting their investment will continue to earn positive returns.


This is an updated version of an article posted on this blog. Click here for the original article.

This article was written by Funding Societies, Singapore’s leading peer-to-peer (P2P) lending platform. They provide working capital loans for small and medium-sized enterprises (SMEs), along with attractive investment opportunities to the broader public. 

Funding Societies is a DollarsAndSense Brand Connect partner. If you are interested to know them better, you can find out more on what they do on our DollarsAndSense Brand Connect Page.

Investing in a Post-US Election World

Prior to US Election Day 2016, most polls had projected a Hillary Clinton victory. So to say that the eventual result was unexpected seems fair. The shock impacted the markets even before the official winner was declared. As Donald Trump’s victory became more and more assured, gold prices soared; the metal is generally seen as a safe asset and a hedge against inflation. Meanwhile, emerging market stocks tumbled and the US dollar reached its highest point since 2003 post-election.

Investors are certainly reacting to the new President-elect’s campaign rhetoric, which is widely expected to culminate in more protectionist policies. Yet all the market fluctuations also reflect anxiety for the future. What will the future hold regarding long-term market stability? Will the markets continue on their volatile streak? Or will they calm after a while? And given all this financial uncertainty, what should the typical investor do?

One thing is clear: we need to prepare for a more unstable world. The best ways for investors to do so is by diversifying their portfolios, hunting for new investment opportunities, and staying calm.

Diversity Your Portfolio

Political events like the US presidential election tend to upset both the markets and investors’ confidence. Some investors have chosen to behave in a more conservative manner (see: the post-election demand for gold), while others have chosen to try and time the market in the middle of all this insecurity by pulling their assets and getting back in later when the markets stabilize.

But timing the market is a very risky affair, even for experts. If you want to fortify your portfolio in anxious times, you should diversify across different asset classes and rebalance your instruments periodically to maintain your risk profile.

Telling investors to diversify is very basic advice, but think about it. Diversifying your investments is something you can control in the midst of uncertainty. You get to choose which instruments to purchase and how much money you are comfortable allocating into each asset class.

The main idea here is to balance the potential for risk and reward. For example, if your portfolio consists of company stocks and precious metals, your stock value may have been erratic over the USA election season, but the value of your gold has gone up. As you can see, with a well-diversified portfolio, you remain in the clear if the stock markets fluctuate for the long-term, as your returns aren’t determined by the performance of a single asset class.

Don’t overload yourself with real-time market information, but do look at all asset classes and see how they will fit into your portfolio and your risk tolerance. The bottom line is: if your overall portfolio is doing fine, then geopolitical situations matter less.

This Is a Good Time to Hunt for New Investment Opportunities

If you feel like your investment portfolio is already well-balanced and you have covered the basics (such as fixed deposits, bonds, gold, and stocks), you can research new places to invest your money. There is an advantage to routinely looking at all the available options and seeing how they fit your portfolio because over time, asset classes produce different results. So to maintain your preferred risk profile, an investment portfolio needs periodic rebalancing.

If the current climate is rendering you a little skittish, you can try investing small sums into alternatives. Technology, for instance, can be a promising sector.

Internet stocks are obvious suspects. Think about how essential brands like Google have become. Yet some tech stocks, such as Facebook and Amazon, have taken a tumble post-election. Some observers opine that this stock slump is temporary, but note that unless you are an early investor in these tech companies, your returns won’t be spectacular. Also, if you already own company stocks in your portfolio, other areas in technology can answer the gap in your portfolio.

Innovative and profitable technology companies are not exclusive to Western markets. One technology-based investment opportunity that has arrived in Singapore is peer-to-peer lending, which utilizes online platforms to match borrowers and lenders. Borrowers take out a loan for working capital or other business necessities, while lenders who had collectively funded the loans earn interest-based earnings in return. Investing in peer-to-peer lending has several benefits: good return rates higher than deposits or bonds, a low entry barrier suitable for those wanting to try the business model first, and a streamlined online process. Despite being relatively new, a recent study by the UK Peer to Peer Finance Association (P2PFA) stated that so long as investors are educated and the regulatory framework is sound, peer-to-peer lending does not create systemic risk. In fact, borrower defaults would need to increase at least threefold to whittle down investor interest rates to below zero.

These days, certain apps can give you real-time updates on your favorite investments or even figure out the best investment mix for you. New opportunities are out there. Take the time to research and find new investments you can be confident in. Look for instruments with good growth that you can feel secure in.

Stay Calm and Don’t Make Rash Decisions

Yes, it can be difficult to enact this advice when your portfolio contains your hard-earned money, future hopes, and retirement plans. Investing can be as emotional as politics, making it difficult to stop watching the markets’ every move. Yet it is counterproductive to over analyze the current situation; there are too many variables. All the information overload can induce panic and cause you to “sell low, buy high” instead of the other way around. Additionally, don’t succumb to the temptation of making speculations. Impulsive decisions can change your portfolio drastically and at the moment, you need a balanced and stable portfolio.

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Should you be interested in learning more about investing in peer-to-peer lending, click here. Funding Societies provides annual returns up to 14%, while maintaining rigorous credit assessment and utilizing escrow accounts for security of funds.