5 considerations before taking up P2P investing
P2P (Peer-to-peer) investments have been increasingly popular as more people are aware of P2P lending platforms. In the past years, these platforms have helped investors generate potentially higher returns.
What are they? P2P lending platforms are the middlemen that connect companies looking for financing with retail investors looking to grow an investment capital. Therein, companies get loans to fund their growth while retail investors get access to an alternative type of investment. When companies repay their loans with interest, investors stand to benefit from the interest.
If you've been thinking about investing with P2P lending platforms, but you're still on the fence as to whether P2P investments are for you, here are 5 questions to ask yourself before putting down your money.
1. What is your risk appetite?
Are you a low, medium, or high-risk investor? P2P investments are high-risk in nature, and if you're a conservative investor, it might not be for you.
If you're conservative and looking for low-risk investments, investing in a high-risk asset might even be counterproductive. For example, if the market goes south, you might feel emotionally drained from holding on to the losses. You might worry too much about what will happen next and end up taking the wrong actions.
Furthermore, when you invest in something unfamiliar, you may not know when to take profit or cut losses. Hence, think about investing in an asset that you're familiar and comfortable with.
2. What other investments do you have?
An important consideration is your portfolio allocation – how much do you have in low-risk, stable assets, and how much do you have in medium to high-risk assets?
If your entire portfolio is in low-risk, highly-liquid assets like savings, fixed deposits, and bonds, this may mean that your portfolio will grow at a slower rate. Having said that, you can rest assured that your assets will always have value and you'll have ready access to your money should you need it for emergency expenses.
On another hand, if your entire portfolio in high-risk, illiquid assets, it means that there is potential for high growth. However, it also means that you may be stuck in losses or losing positions for prolonged periods, especially if you're caught in an economic recession. What happens then if you need cash for emergencies? Would you sell your investments at a loss?
Hence, it's important to think about having a mix of both low-risk-low-yield and high-risk-high-yield assets in your portfolio. Depending on your risk appetite and technical knowledge, you can then decide what proportion to allocate to different types of assets.
3. How much do you plan to invest?
P2P lending platforms have different projects, which require different minimum amounts for investors to participate. This amount ranges from as low as $20 for some projects on Funding Societies to a minimum of $5,000 for projects on CoAssets.
As the required investment principal is very different, you should plan ahead to determine how much you can afford to invest in P2P investments and choose a platform that matches your needs. Of course, there are other considerations besides just the minimum investment sum. For example, the type of projects, the industries, the creditability of the companies and their directors, and the loan terms should be considered.
Instead of asking yourself how much you plan to invest, you can also frame it as how much can you afford to lose? As P2P investments are highly risky, you should consider the worst-case scenario where you end up losing your principal totally.
4. How much time can you devote to background research?
With P2P investments, the platforms do the first round of screening, curate projects to be listed, and present them in an easy to understand manner. Compared to the hassle of sifting through thousands of companies when you invest in the stock markets, this cuts away a lot of the time and effort needed for research.
Having said that, you'll still have to do your due diligence to understand the projects and the terms of the loans. There might be projects that involve industries you're more familiar with or projects with more preferable loan terms for investors.
Do not just throw your money into every other P2P project and call that diversification because that's just being careless with your investment; it's a sure way to lose in the long run. Put in the hours to research and invest selectively.
5. Do you have a backup plan?
When we say that P2P investments are very risky, do you know the risks entailed?
While P2P investments have performed in the past years, we cannot assume that the returns will always be positive. Further, there is always the risk that the borrowing companies may default on their loans.
As the intermediary service provider, P2P lending platforms have to do their part to mitigate these risks. However, as an investor, it's up to you to manage your own risk when investing.
What happens if your money is stuck on a P2P platform when a borrowing company defaults or if the P2P platform ceases operations? Are you able to get by your usual livelihood without the money? And if you need cash to pay for an emergency, do you have savings to fall back on?
That's why the liquidity of assets is an important consideration for your backup plan. Just like how the saying goes that we should always save for a rainy day, you should have some stable, low-risk asset as a backup.
All investments carry risk. Instead of avoiding risk and missing out on investing totally, you can also choose to learn more about the different assets and various investing concepts. Dedicate some time to do the research and compare across P2P lending platforms to find one that suits your needs.
These small steps can go a long way to helping you succeed in your investing journey.