At Lendwise, we want our lenders to make sure that the investments they make are in line with their appetite for risk. When we talk about “risk”, we see it as a measure of the uncertainty of achieving the investment returns in line with the investor’s expectations. Below we highlight some considerations that P2P investors should take into account when making P2P investments.
Remember, if you are unsure about P2P investing, you should seek independent financial advice from an FCA authorised independent financial adviser.
One of the biggest dangers that investors face is what is known as ‘concentration risk’ – this is regardless of the type of investment they make.
Concentration risk can be described as “having too many eggs in one investment basket”. In other words, concentration risk is when your portfolio is too heavily weighted towards one particular security or asset class.
Diversification to strengthen an investment portfolio
Diversifying a P2P portfolio can strengthen it by reducing concentration risk. Let’s say you decide to invest your wealth by buying shares. If you invest your entire wealth into the shares of 4 companies, then you will have a highly concentrated investment portfolio. If just one of those companies goes bust, then your investment portfolio would lose a big proportion of its value in one go. That is why diversifying by spreading your investments around properly can balance your portfolio so that even if an investment doesn’t work out, its impact on your overall portfolio is limited.
Since diversifying your investment portfolio reduces concentration risk, an investment portfolio that is highly diversified should be less volatile (and thus generate more stable returns) when compared to a concentrated investment portfolio. That is why it is considered sensible for all investors, including P2P lenders, to diversify their investments.
Below are some tips on how you can successfully diversify your portfolio.
- Lend to individuals and companies
Certain P2P platforms facilitate unsecured personal loans to individuals, while others arrange business loans. To ensure that you are not too exposed to just one of these types, you might choose to diversify your investments across both of these types of loans.
- Lend to a range of borrowers
Another way to diversify your investment portfolio is by lending to a mix of borrowers. For example, on the Lendwise website, there will be borrowers from a range of profiles with corresponding interest rates that you can earn from lending to them. By doing this, you will ensure that your investment portfolio is not exposed to any one lending segment.
- Lend at various interest rates
Generally speaking, the higher the lender interest rates offered by P2P loans, the riskier that loan will be. By lending only at the highest-available interest rates, you increase you risk of loan defaults, bad debts and write-offs. Therefore consider investing in loans across a wide range of interest rates. This will ensure that your P2P portfolio has a sensible balance of low-risk and high-risk loans.
- Lend across various time periods
In addition to lending across different interest rates, you can also lend across varying time periods. P2P loans range in duration from as short as one month to as long as ten years. By investing across this time horizon, you may reduce the risk that your P2P investment portfolio becomes too concentrated over any one time period. This also has the added benefit of better liquidity as at any point in time, you may have a loan close to maturing which gives you access to your cash.
- Lending using auto-diversifying
Many P2P platforms offer an ‘auto-lend’ option that employs software to automatically divide your funds across a wide range of P2P loans. Lendwise also has an auto-lend option where, taking into account the points discussed above, you can set your criteria for the wide range of loans that you would like to invest in, and Lendwise’s software would then automatically diversify your funds for you across all available loans according to your specified criteria.
As with most forms of investment, peer-to-peer lending carries a degree of risk to your capital in the event that borrowers are unable to repay their loans. Please consider reading our Key Investor Information before making investments on Lendwise.com.