P2P Lending To “Beat Most Other Asset Classes”

Zopa‘s* Giles Andrews yesterday said of the new P2P lending ISA (from April 2o16) that it “will, I believe, provide reliable, predictable and low risk tax free returns that will beat most other asset classes.”

Beating savings is easy

Certainly it will outperform savings accounts and cash ISAs most of the time.

If lenders can't get enough interest to comfortably beat cash savings then they usually won't take the extra risks. They'll pull their money out of P2P lending until interest rates rise again.

Being less volatile than shares ain't hard either

And most lenders' returns will undoubtedly be less volatile than the stock market, most of the time. Even in a good stock market year, a decent sized minority of share investors will lose money.

P2P lending, in contrast, has been incredibly stable with the vast majority of lenders – with over 120,000 P2P lending accounts – who have spread their money across lots of loans all making a profit overall for the past ten years.

That record will worsen. There will be booms and busts in peer-to-peer lending as there is in any investment, and those who don't pay attention to warning signs will suffer.

But, overall, we can expect returns to be more steady due to the nature of lending, and for recoveries from losses to be swifter than with the stock market.

Higher risk leads to higher average returns

While P2P lending has beaten the stock market over the past ten years, it is unlikely that P2P lending will beat shares – or property investing – on average. Not in the long run.

While some P2P lending websites offer very high-risk loans, P2P lending's natural fit is between savings account risk and stock market risk.

History shows very clearly that, on average, higher-risk investments have higher returns.

It stands to reason really: investors will only usually invest at a price that they believe will give them enough rewards for the risks they're taking.

They get it wrong sometimes. And the more risky an investment is, the more wrong investors are likely to get it, especially during times when everyone is feeling particularly euphoric and greedy, or fearful and panicky.

But on average it works out that way.

An example from property investing

Look at it this way.

A property investor has to ensure that the expected rewards cover not just the mortgage costs, but also gives him/her a profit on top.

Plus, since lenders get to repossess the property in the event the investor fails, the property investment is where the risk really is.

So the property investor has to be going for a higher return than the people or businesses that are lending the money for the investment.

Funding Circle‘s* Luke Jooste said on a panel show at the Property Investor Show in London (chaired by 4thWay's own Neil Faulkner) that, at a minimum, he expects that property developers should be going for a return of 15% on their investment at the very least.

Whereas those of us lending to property developers can expect to get maybe 8% or so after costs but before losses. Lower potential rewards for lower risks.

P2P lending versus other investments

There are plenty of other investments I could compare P2P lending too, but there aren't many more that I feel have a good balance between getting enough reward for the risks taken.

This imbalance often occurs due to a lack of understanding or information about an investment.

Take gold, for instance. If you were familiar with the seven things that Warren Buffett – the greatest investor in the world – has said about gold, you might not be so in awe of it as an investment. Many people don't, and never will, get it, however.

Another example some of you might be familiar with is structured growth bonds linked to the stock market. They sound all amazing, like there's only a massive upside with little potential downside. But their high costs are hidden in such a way that they don't even have to be mentioned in the small print. Those costs shift the risk-reward balance dramatically out of your favour.

I think those particular products might also be frequently marketed to people who don't understand the hidden costs, which helps providers to profit from naivety.

For my shortlist of worthwhile investments, read: The Investment That's Better Than P2P Lending.

More: get early warning signs that your favoured P2P lending websites are heading from boom to bust by subscribing to 4thWay's newsletter below.

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