How Much Money You Should Invest in Peer-to-Peer Lending and Why?

How Much Money You Should Invest in Peer-to-Peer Lending and Why?

I am still amazed how people are often making a rushed decision to invest in P2P lending while having no idea how much money is enough. They don’t fully understand in what they are getting into.

My goal is to try change that mindset.

Before investing in peer-to-peer there has to be a clear decision making process.

You’ll have to consider P2P as a part of a broader investment portfolio, along with stocks and bonds. You can’t be 100% invested in P2P.

You need to learn about asset allocation and understand how much money to invest to keep risks under control but also get the best of it.

The purpose of this post is to help new investors get a better start with P2P lending, making smart decisions to avoid potential problems down the road.

As for experienced investors, I wish you can find this useful, too. In fact, I would be very happy if you jump in and share your thoughts on the subject. I’m always looking for someone to challenge me, so that we can all grow together.

No strategy in place when deciding to invest in P2P lending

Taking the time to understand a new investment vehicle from all angles is important before making any decision. You need to do your due diligence, otherwise, you’ll probably lose money.

Unfortunately, when it comes to P2P lending, I believe this is overlooked more often than when investing in stocks or bonds.

Is probably related to the false sense of security peer-to-peer lending can give you. And in the heat of the moment, amazed by the high returns, only few investors will spend enough time to do proper researching and learning.

They feel they got it, and they are very eager to start. There is no thinking, no analysis, no strategy in place.

They don’t understand the risks and they don’t ask questions.

Smart questions, like:

What happens if Platform X will go bust? How likely is that to happen? If it happens, will I be okay with that? How I can protect myself against that?

They most probably heard from a friend or read somewhere online, and saw how easy is to get high returns, and thought of trying.

I feel that is my responsibility to get that straight, and make sure people are making an educated decision when investing in P2P lending.

You see, I was like that in the beginnings.

I started with 4 platforms, and a bigger amount of money than I should have. I wanted to put in 5.000 EUR for starters, but changed my mind and turned that into 10.000 EUR, but in reality my initial transfer to platforms was around 15.000 EUR.

As you can see, I increased amount to invest from 5.000 EUR to 15.000 EUR without any clear reason.

What was I thinking?

That’s the perfect example of emotional decision driven by greed!

Looking back, that was such a rookie mistake! I had no plan and no idea what I was doing.

It took me almost a whole year to realise this.

After that, I quickly changed things around and started to come up with a strategy, not just for P2P lending, but for my entire investment portfolio.

I understood I had too much exposure on P2P (more than I wanted – almost 20% of my portfolio), so I quickly downsized to around 10%.

The whole thing started to look more like a balanced investment portfolio, as it should be!

The downsize of my P2P portfolio

My ultimate goal for me (and should be for every investor out there) is to build an IPS (Investment Policy Statement) which will serve as a framework for making smart investment decisions that don’t involve emotions.

For me that’s still work in progress (as is definitely not easy to do) and will post it on the blog as soon as I have it ready.

Until then, any rough plan or strategy is better than nothing. I encourage you to spend a little bit of time and think about this.

Why P2P lending is a good addition to any investment portfolio?

Although many consider peer-to-peer as trash, I think we need to keep an open mind and embrace the new. Sometimes you might be surprised!

I believe that in 10 years from now we would see P2P in a lot more portfolios. Is just a matter of time for people to get more educated, and for the industry to evolve and mature.

However, the earlier you get on this train, the better, as long as you keep your eyes wide open to not fall off 😉

As one of my friends was saying, we are in the golden age of P2P lending. Don’t miss this wave! Returns will only go down with time!

Alright, enough with the small talk.

Let’s see 3 reasons that make P2P lending a good choice to any investment portfolio.

REASON #1 – Little correlation with stocks and bonds

The key for a diversified portfolio that will do fine no matter of economical cycles is the low correlation between the assets in contains. If one asset goes down, others may go up, and thus maintaining a good balance.

That’s why is important to understand how P2P lending compares with stocks and bonds, and how that can help us.

A study from 2015 shows that by allocating around 13% of your portfolio to P2P will increase diversification, and decrease volatility.

They calculated the correlation between the main asset classes (stocks, bonds, etc…) and peer-to-peer lending and demonstrated that there is little correlation between them.

Check out the table below.

Assets correlation

To better understand it, I will clarify that a value of 0 represents no correlation at all, while a value of 1 would mean perfect correlation.

If we take a look at the stock market (the area highlighted in yellow), we can see that the correlation is less than 0.2. Same thing happens with bonds (the green area) where we have no correlation at all.

Conclusion is clear. There is little correlation with stocks and bonds, which makes P2P lending a great addition to any investment portfolio. It helps reduce risks (true diversification), keeping a good balance while also maximizing returns.

REASON #2 – Low volatility compared with stocks and bonds

The price of a loan is not changing. At least not like the price of a stock or a bond does.

I am not talking here about premiums and discounts on secondary markets. Most of the platforms don’t even have a secondary market. And even if they have it, the price of a loan is influenced by other factors which are more related to the underwriting assets, as it should be, rather than political or other unrelated factors.

I am talking about major events that happen around the world, and usually have a big impact on the stock markets.

However, there is little change to P2P Lending when that occurs.

You see, our P2P portfolio will be just fine if Trump decides to tweet on God knows what, like the Mexico wall or the trade war with China. Or if Brexit will finally happen, or not, or yes, or… you get it!

For peer-to-peer investments is just business as usual. While the stock market reacts immediately out of fear.

To show you what I mean let’s take a quick look at the stock market.

Will take S&P 500 and the VIX index. Everyone knows what S&P 500 stands for. As for the VIX, or the fear index, when it goes up investors are nervous and concerned about the stock market and its future. When the value goes down, investors are confident and without much fear.

Now, in the graph below, observe how the stock market goes down, and VIX goes up. And how all the movements are related to major events that created fear and concerns among investors, like US elections, the trade war with China, and so on.

S&P 500 with VIX and major events that influenced them. Source here

Next, let’s take a look at another graph that paints the same story. This time is about bonds. On the X axis we have volatility and you can see how the major fixed income assets are more volatile, while lending is very close to 0, which means little volatility.

Major fixed income assets annual returns vs volatility. Source here

Clearly, from what we have seen so far, peer-to-peer lending is much more predictable than bonds and stocks. You kinda know what’s going to happen.

This low volatility compared to bonds and stocks will make a difference to your investment portfolio, keeping a good balance and give you peace of mind.

To paint the full picture and be fair, is good to know that lending is not something magic which is not impacted by anything.

Actually it is, but is more related to the loan itself, rather than arbitrary.

For example, real estate loans – they are influenced by the property markets. If those markets drop a lot, the value of the asset underwriting the loan may drop and affect the LTV (Loan-to-Value) rate.

Or take consumer loans. Those are being impacted by the unemployment rates, which makes a lot of sense. No job, no money to pay back the loans.

REASON #3 – P2P lending might do better during recessions than stocks

Let’s be straight.

In reality we don’t know exactly what will happen with P2P lending during bad times.

However, we can try guessing, taking a look at the little data we have.

As P2P platforms behave differently based on the loan types they serve, we will take a look at consumer loans and then real estate.

Starting with consumer loans, we can analyze the credit cards industry from US and how it performed during last 2 financial crises. I believe is a good comparison, as P2P consumer lending is similar to how credit cards work, which is essentially unsecured consumer debt.

We can see below how credit cards performed for the past 20 years.

Net return on credit cards for the past two decades. Source here

There are two clear dips in net returns, associated with 2 crises, but banks never lost money. The returns always stayed in the positive territory.

So banks made a profit while the stock market fell like 50% in 2008, the worst economic crisis since the Great Depression. Amazing, right?

Now, let’s move our attention to real estate.

Clearly residential and commercial real estate will not do well during hard times. People will not buy houses anymore, companies will not look for new offices for renting, and so on. The prices will certainly drop.

But how will that compare with stocks?

Well, we can take a look at the 20-year annualized returns by asset class to get an idea.

20-year annualized returns by asset class (1999 – 2018)

As you see, REITs outperformed stocks (S&P 500) by far, almost doubled the returns.

This may give us some clues of what we can expect in the future, but I will not hold my breath. Is really not the best comparison, so take it with a grain of salt. Further research I did hasn’t revealed anything else useful when comparing real estate with stocks.

However, I would like to mention one more thing. If one of the real estate loan originators would go bust, there are still hard assets that can be sold (the properties themself), and some of the money will be recovered and returned to investors.

To finalise our analysis we will also take a look at Zopa, who is the first P2P platform that launched in 2005 in the U.K.

Again, don’t take this for granted. Zopa is an old generation platform and returns there in general are below stock market returns, and for sure below new generation platforms like Mintos or Grupeer.

However, nothing holds us back to see how they did during 2008 financial crisis.

Spoiler alert: they did great!

From the graph below you can observe there was a small dip in 2008, but they still managed to generate positive returns. Go here if you want to learn more.

Average annualised returns of different asset classes. Source here

So, would P2P lending be a good addition to any investment portfolio?

For me it’s a clear YES!

The little correlation with stocks and bonds, low volatility and the potential to actually do just fine during bad times is making P2P lending a great way to diversify your investment portfolio.

How much money should I invest in P2P Lending?

I will start by saying what not to do.

  • Do not invest all your money! Or even half of it.
  • Do no invest your emergency fund – if you have one. If you don’t, create one, then invest.
  • Do not borrow money to invest.
  • Do not invest money that you can’t afford to loose.

So please don’t do any of that.

Now that we got a few things straight, let’s dig in and see how much money should we put in P2P lending.

To get that answer we need to take a look at the whole pie available for investments and see how we can spread that across asset classes.

Yes, you should also invest in stocks, bonds, crypto (why not?), classic real estate, and so on.

And, no, I don’t think over exposure in P2P is a solution if you lost money in the stock market. You might have the same problem here in the future. Think about that.

The key here is diversification across (uncorrelated) asset classes.

Therefor, I’m advocating for a balanced portfolio that has stocks, bonds and P2P at the same time. I won’t debate the percentages for stocks and bonds, as that’s a very long discussion. Instead we will fully focus on P2P lending as part of this larger investment portfolio.

Knowing that this is a medium-to-high risk investment, we want to make sure that we only invest a small portion of our money.

But how much is too much?

I won’t tell you to invest 100 EUR, 1.000 EUR or 10.000 EUR. I wouldn’t know which one is right for you. However, I will give you some guidance in terms of percentages of the whole investment portfolio.

So here is what I think.

Depending on your risk profile, I recommend investing somewhere between 5% to 15% of the entire portfolio.

5% should be for the conservative profile (low risk), 10% for the balanced one (medium risk) and 15% for dynamic profile (high risk).

As I have a balanced risk profile, I fit at 10% and willing to take a little bit more risk for better returns.

I am actually in a great position now, and where I should be, according to my plan.

If you remember, I briefly mentioned above that I was having 20% exposure to P2P lending in the early days.

I understood that wasn’t right for me and set my goal to reach to 10% and I succeeded. Now I feel much more comfortable.

Take a quick look below and see how the asset allocation looks like for my portfolio:

For me P2P lending will never take a bigger piece of the pie that stocks and bonds, as is a riskier asset, no matter how many other benefits it provides.

The role of P2P lending in my portfolio is to provide steady returns, reduce volatility and also maximize the overall returns.

My personal opinion is that anything above 10% has the potential to get us in trouble and is not worth the risk.

So be smart, and don’t lose money! That’s the first rule when investing.

I will add an unrelated note about cash, as that can raise a few questions. There are 2 main reasons it takes the biggest part of my portfolio:

  1. As we are towards the end of economical cycle, I’m staying prepared to be able to benefit of opportunities in the stock market.
  2. We are looking to purchase a property.

As a conclusion

Everyone is different. What works for me, might not work for you. Don’t take what I said as the only truth.

Do your own due diligence, understand yourself better, know your risk appetite, and come up with an overall investment strategy that works for you.

That’s the best and safest way to know if P2P lending is for you. Do that and you’ll also be able to easily answer the question on how much money to invest.

What do you think?

Have you already invested in P2P lending, and how you made that decision? Is there anything you would do differently?

How much money you have currently invested in P2P lending?

Do you think P2P is a good addition to an investment portfolio? Why?

Feel free to leave a comment in the section below.

Until next time,
Marius

P.S. In the next post we will discuss on how to invest 10.000 EUR as a lump sum in P2P lending. I will show you what platforms I will choose, and how much money to invest exactly into each one.

Disclaimer: This is a personal blog, containing our opinions and views, and nothing you read here can be used as investment advice or recommendation. You should also know that some of the links in this post may be affiliate links, meaning, at no cost to you, I may earn a commission. Read the full disclaimer here.

8 Comments

  1. Smart advice! I personally am well diversified, and keep 30% in p2p platforms (some of those are in Real Estate – Rent projects, which is very conservative. Crypto at the moment is at 2%). Why do You have 47% in cash?

    1. Hi EvoInvestor, and thank you!

      First, I will like to say that I quickly looked at your blog and looks really interesting. Definitely going to check it out in detail!

      About your question, interesting that another reader asked the same thing 🙂 I have multiple reasons why I have that much cash:
      1. As we are towards the end of economical cycle, I’m staying prepared to be able to benefit of opportunities in the stock market.
      2. We are looking to purchase a property, either for investment purposes, or to replace our current home. In that case our current home will be rented.
      3. We are still working on our Investment Statement Policy which will guide all our investment decisions. Until then we are taking it slow to make sure we aren’t doing any huge mistakes. We really don’t want to loose our hard earned money.

      I would like to say one more thing. Until a few months ago, we were really pressuring ourselves to do something with this big chunk of money. Now we are cool with that. And the reason is simple. We realised that it’s more important to focus on our active income, as we are young and currently in the wealth accumulation period. On top of that, economy is still in a good shape, so easier to make money now in that way. Once the recession comes (and it will), we will take all of the money we accumulated and invest in all the great opportunities that will be on the markets.

      Best,
      Marius

  2. Thanks for the great, well-researched article, Marius! My wife and I have 17% of our portfolio in P2P lending at the moment, we’re aiming for an aggressive 25% allocation long-term. The rest is in ETFs, cash, crypto (which just grew a lot again and needs to be rebalanced) and real-estate. I personally love the cash-flow aspect and the predictability (at least so far) of P2P investing.

    1. Hi Angelo!

      Thank you for your kind words. Appreciate that!

      It’s a great feeling to check your account month, after month, and see how interest is piling up. Very rewarding indeed 🙂

      I think I was watching your Grupeer review a few days ago on your YouTube channel. Great work! For what ever reason I wasn’t aware of your blog, so going to check it out. Will love stay up to date with your progress 😉

      Best,
      Marius

        1. Angelo, thank you for the invitation to join FIWE! We are definitely considering to join next year. It will be the perfect opportunity to meet new like-minded people 🙂 Cheers!

  3. Thank you! Very interesting reading.
    You have 46,86% of your assets in cash & deposits. Why is that percentace so high? Are you planning to re-allocate cash in the near future?

    1. Hi Indrek! Thank you for stopping by.

      That’s a very good question. There are a few reasons that percentage is so high:
      1. As we are towards the end of economical cycle, I’m staying prepared to be able to benefit of opportunities in the stock market.
      2. We are looking to purchase a property, either for investment purposes, or to replace our current home. In that case our current home will be rented.
      3. We are still working on our Investment Statement Policy which will guide all our investment decisions. Until then we are taking it slow to make sure we aren’t doing any huge mistakes.

      Best,
      Marius

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