Should I invest with P2P lending platforms?
If you're looking at different types of investments, you might have heard of the term "P2P lending" or crowdfunding. Many people would consider it as an alternative type of investment as opposed to the usual savings account and fixed deposits, or the slightly riskier bonds and exchange-traded funds (ETFs). But what exactly are P2P lending platforms and how do they work?
What is P2P lending?
Contrary to what it sounds like, peer-to-peer (P2P) lending in this context is not so much about an individual loaning money to another individual. Instead, it's more of retail investors loaning money to companies, or a company trying to raise money from the crowd i.e. crowdfunding.
Retail investors refer to your mom-and-pop investors, so almost anyone can invest in P2P investments as long as they are registered and verified by the P2P lending platforms.
Traditionally, companies will go to banks or finance companies to borrow money when they require a sum of capital to grow or to tide over a short-term cash flow deficit. Companies also have the option to take on equity financing by giving up a small stake of their company, or debt financing where they take up loans and repay with interest. Only accredited investors can partake in such deals.
In Singapore, you're required to have a salary of $300,000 or more in the preceeding year, or have net assets with a value of at least $2M to qualify as an accredited investor. Source: Monetary Authority of Singapore
P2P lending platforms opened up a new way for these companies to raise funds by acting as the intermediary between companies and retail investors. That is to say, they vet through companies looking to take on debt financing, and match them with qualified retail investors who are looking to participate in the investment round.
How do P2P lending platforms work?
Companies who need loans can approach these P2P lending platforms. The platforms will also actively seek out such companies through their network. The P2P platforms will then screen through these companies and assess the deals to see which ones are viable before listing them. In a way, P2P lending platforms are performing the first round of due diligence.
As per all loans, they come with interest. Companies will have to pay back interest on the loans, and that is the potential interest that investors will be getting on their investments.
For P2P lending platforms, they earn by charging a service fee to the investors, taking a commission from the investors, or charging a fee to the companies. The business models vary across P2P lending platform, so it's important to understand this aspect of their business because it can affect how much you get back as an investor.
With P2P investing, companies get another option to raise funds while retail investors get an opportunity to invest in an alternative type of investment – a win-win situation for both. That's assuming all goes well, the companies pay back their loans and the investors get back their capital with interest on top.
All investments come with risk. While P2P investments offer a higher rate of return than savings accounts and fixed deposits, they also carry a greater deal of risk. Here's what you should be aware of.
What are the potential upsides of P2P investments?
As an investor, if you're looking to diversify your portfolio with some riskier investments, you'll typically look at stocks or a basket of stocks (an ETF). With stocks, you're looking at annualised returns of 7% to 15%. This amount further varies depending on how you choose to invest in stocks.
For example, the two most common methods for stocks-investing are value investing and growth investing. Both methods require extensive technical knowledge, and investors will also need to spend time and effort to research on companies that fit their investment profile.
One of the upsides of P2P investments is that the P2P lending platforms do the first round of screening, and they cut away the need to research from thousands of companies. Investors still have to put in the effort to learn and understand the projects on the platforms and the deals involved, but the reduced scope of companies makes it easier for the less technical and less experienced retail investors to start investing.
Over the past years, P2P investments have also generated around 8% to 11% annualised yield, which is a comparable rate of returns with stocks and commodities. And if you compare it with putting your money into a savings account or fixed deposit, you'd have gotten 3 to 4 times more returns. Having said that, there are several things that investors should take note of:
- Past performance is not indicative of future results. No one can guarantee that the following year will see as good a return on investments.
- Higher yield also entails higher risks. You should be very wary of the risks involved in P2P investing.
- It's not advisable to park all your money into one particular type of investment. Instead, think of it as an option to diversify your portfolio.
What are the risks involved with P2P investments?
With P2P investments, there's always the chance that the companies do not make good on their borrowed loans – their projects fail and they end up defaulting on the loans.
It might even be as bad as the company closing down and all their debtors will be looking to get back their money. As someone who invested through an intermediary, what order of priority do you stand in getting back your money?
That's when you have to be careful and to be aware of the terms of the loans. Depending on the projects and their respective terms, you may even be in the top order of priority to receive back your money for some projects.
For P2P investments, payments that are not received within 90 days of their stipulated deadline are considered as non-performing loans. Investors may get back their money later than expected, or they may not get back the full sum of their investment capital in the worst-case scenario. As per MAS regulations, all licensed platforms are expected to publish their performance on loan securities in the past 3 years, which can be found on their websites.
Over the past years, rates of non-performing loans for P2P investments are relatively low (generally below 5%), and CoAssets even had a 0% rate in 2018. Nevertheless, we cannot assume that default rates will always be this low.
Savings accounts, bonds, and fixed deposits are backed by institutions and further backed by the Singapore Deposit Insurance Corporation Limited (SDIC) up to $75,000 per bank. This means that even if the bank folds or in the event of a bank run, you'll be assured some money.
In comparison, your money is left in the hands of the platforms with P2P investments. As an intermediary, it's their responsibility to help you claw back your money if the companies default on their loans, but there's no saying what can happen if the whole economy collapses. That's also why it's highly advisable not to put all your money into one type of asset.
Should I invest with P2P lending platforms?
Now that you understand what P2P investing is about, its potential upsides and downsides, what can you do with all the information?
Research on P2P platforms
One, you can start by doing some research on the different P2P lending platforms. While the platforms generally operate in a similar manner, there are differences in their business models, the fees involved, and also the types of projects on the platforms.
For example, CoAssets specialises in curating and structuring deals across various industries such as movies, FinTech, properties, and F&B. They also charge no fee on the investor end as they get their profits from charging a fee to the companies. However, the minimum that you'll need to invest is $5,000, which is quite a big sum compared to the other P2P lending platforms.
Have a diversified portfolio
Next, you should also put some thought into your own investor profile and your ideal portfolio allocation. While it's good to have a portion of your portfolio in conservative low-yield assets, and another portion in riskier growth assets, the actual proportion depends on your investment capital and risk appetite.
This portfolio also relates to your familial commitments and your lifestyle. While you'd ideally find a way to grow this portfolio as much as possible, you'll also want to make sure that you have liquid assets that can tide you over in the event that you're unable to work and have to rely on your investment portfolio to get by.
Do your own due diligence
Lastly, if you've chosen to do P2P investing, remember that you still have to do your homework. Although P2P lending platforms screen through the projects, if you haphazardly put your money down into every single project without understanding what you're investing in, it's the surest way to lose your money.
When the economy goes down, there are no guarantees that all these companies will be able to make good on their loans. Always be wary, and always protect your downsides.