In the last few years, the global investment landscape has witnessed the arrival and rise of a new investment option – Peer to Peer Lending. P2P Lending platforms are trying to democratize the traditional lending-borrowing process which was primarily controlled by banks and financial institutions. These platforms offer a great opportunity to Retail Investors as they can lend money to Retail Borrowers directly without the intervention of any bank. Both investors and borrowers have something to gain from this as the lenders get an opportunity to earn up to 30 percent returns whereas borrowers get easy access to loans at interest rates proportional to their risk classes. In this article, we will highlight the five key elements of investing in peer to peer (p2p) lending.
Investing in Peer to peer (p2p) Lending is independent of ‘Market’ risks
All investments have some risks associated with them. While investment in stocks or mutual funds exposes you to market risks, by investing in peer to peer (p2p) lending, your investment is not affected by the volatility of the market since your funds are not invested in market-linked assets. With P2P Lending, you are simply offering a loan to a borrower. Therefore, there are no market risks involved or fluctuating portfolio value or the pressure of finding the right time to sell.
Having said that, P2P lending has its own set of risks. The primary risk is that of default or a borrower not repaying the loan taken by him. There are many ways to minimize this risk. More about that later in this article.
The only exception is large-scale events which impact the overall economy of a country and reduce the loan repaying capacity of the borrower.
Diversification is a great tool to minimize the risks associated with investments. By creating a diverse portfolio using an optimum mix of various asset classes, you can ensure that the investment risks are minimal.
Most P2P lending platforms offer a double diversification option. This allows investors to mitigate investment risks while managing their portfolios via a single dashboard. An investor can choose between five different risk classes to determine the ratio in which you want to invest. This determination can be made based on the financial objectives and risk preference of the investor. Once this determination is made, the investor can choose multiple borrowers from each risk class bringing down the risk exposure per borrower to a small amount.
Compound Interest, in simple words, is the interest earned on the interest earned by your investments. In Albert Einstein’s words, it is the eighth wonder of the world. Compound interest plays a huge role in offering great returns on investments.
When you invest in peer to peer (p2p) lending, you start receiving EMIs every month. These instalments have a part of the interest and the principal amount. In order to benefit from the power of compounding, you can choose to reinvest the entire EMI or just the interest component.
While investing in market-linked options like mutual funds or stocks, the volatility of the market can affect your investment value. On the other hand, with peer to peer lending, you can actively manage your investments with ease. Once you have invested keeping your risk preference and financial goals in mind and diversified well, your risks are minimized. You can add investments or monitor/manage them as and when you want.
Choosing the right Peer to Peer Lending platform
Currently, there are nearly 30 P2P platforms offering services to investors and borrowers in India. In such a landscape, choosing a good peer to peer lending platform can be an overwhelming process. However, it is important that you research well and choose the right p2p platform since you rely on the risk class assigned by the platform to all prospective borrowers to assess the investment risk. People Lend, one of the leading names in peer to peer lending in India, uses proprietary software to assess all aspects of a prospective borrower before assigning a risk class. The factors taken into consideration were the CIBIL score, income details, occupation details, area of residence, trends in expenditure, etc.
Further, if there is any delay in receiving an instalment, most platforms have a recovery process wherein the follow up with the borrower for the missed payment. Hence, it is important to check the recovery process of the platform before signing up.
Before you start investing in peer to peer (p2p) lending, ensure that you keep these five points in mind. P2P platforms provide a great investment alternative but require you to understand the investment process before investing. Start slow and build your confidence before you invest a sizeable portion of your portfolio.