4-Step Strategy to Safe Peer-to-Peer Lending
This page was last updated on 15 June, 2018
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- The four steps in brief
- 1. Lend regularly
- 2. Spread your money around
- 3. Commit to five years of lending
- 4. Spread your money between outstanding P2P lending companies
- Maintenance. Keep an eye on rising risks
- Focus on safety, not high interest rates
- The rewards are good too!
- This was part five of our ten-page P2P lending guide
Safe peer-to-peer lending is not as risky as the stock market. Not by a long shot.
However, as with the stock market, the risks in P2P lending, including IFISAs, are not uniform. Some lenders will lose a lot of money over the next half century, simply because they don't have a plan or do no research.
That said, the risks in P2P can be reduced to a very low level with a simple, sensible strategy.
At the same time, the probable returns increase with a sensible plan, because lenders who focus on containing the risks get better results in the long run.
The four steps in brief
1. Lend regularly and re-lend repayments you receive.
2. Spread your money (and risks) across hundreds of loans.
3. Be prepared to commit to at least a medium-term (say, five-year) lending period if necessary.
4. Spread your money between a lot of different P2P lending websites and/or P2P IFISA providers with outstanding 4thWay PLUS Ratings combined with clearly high-quality services in picking loans or setting interest rates.
1. Lend regularly
As we have seen in other investments, such as shares, you dramatically lower your risk of losses if you're lending your income every month or three months, rather than just putting one lump sum in. You also need to re-lend the repayments and interest you receive.
The reason is that, if you do this, you can't accidentally put all your money in before an economic collapse. By spreading out, you get good deals and bad, but on average you can expect to do just fine. Perhaps even better than fine if you follow our other three steps:
2. Spread your money around
You wouldn't buy just one share on the stock market with all your savings. (We hope!)
Lending all your money to one borrower is also a highly risky thing to do. Imagine if a bank manager did that? She'd get fired from head office right away.
You should aim to spread your money between at least 100 borrowers. If you're going for higher-risk peer-to-peer lending companies, because you want to try and get higher interest rates, you should aim for considerably more than 100 borrowers.
Thankfully, many P2P lending websites make this easy by automating it for you and splitting your money between lots of borrowers.
In addition, you should spread your money between several P2P lending websites.
3. Commit to five years of lending
The stock market is so rocky that you can't even be confident of coming out well over 10 years.
Peer-to-peer lending is lower risk, because it's easier to predict what might go wrong with a basket of borrowers in a recession, and set interest rates accordingly. So we're confident that five years of regular lending and re-lending will see most people come out fine after five years.
That's even if we go through a bad economy where borrowers are going bad by the truckload. But you can only be kind of blase about lending over five years if you also follow rule four:
4. Spread your money between outstanding P2P lending companies
The vast majority of us should stick to the P2P lending companies and IFISA providers who take multiple steps to protect your money. They go for super-prime borrowers. Or they only lend your money against property that is valued much, much higher than the loan that is taken out.
They also usually have other defences which contribute to earning 4thWay PLUS Ratings. These things, which are weighed mathematically using international banking standards when calculating their ratings, include:
- The type of lending.
- The results of each historical loan.
- The interest rates.
- Whether they have pots of money set aside to pay expected bad debts.
- Directors of the P2P lending companies promising to take the first loss on all loans.
- And many other items.
Maintenance. Keep an eye on rising risks
If you follow the above 4-step strategy, you can expect to come out with satisfactory rewards, even if you have to suffer extra losses due to a recession similar to 2008.
However, while the P2P lending websites you put your money in today might have extraordinarily good borrowers and defences against losses, that won't always be the case for all of them. For some of them, their standards will slip.
So you have one more bonus task to do, which is to watch out for warning signs their standards are slipping and get out when you no longer recognise it as the safe company you first lent your money through.
These warning signs can include such things as late payments rising much faster than other P2P lending websites, much more loan applications being accepted and bad-debt provision funds shrinking fast.
Not all these P2P lending companies will retain their great 4thWay PLUS Ratings forever and subscribers to our email will be first to know when any of the P2P lending companies' standards are slipping.
Focus on safety, not high interest rates
Even when lending your money through the safest P2P lending websites, you should expect to earn an attractive premium over savings accounts, and that's after fees and taxes. Anything less and you have to begin to wonder what you're taking the risk for.
However, the most successful investors in other fields focus above all else on avoiding losses. That's right, while many people chase higher risk to get higher return, they're gambling in a way that, for most of them, will not pay off.
Many of the peer-to-peer lending websites have given zero losses to lenders. Others will have done just as well if you had spread your money among 100 of their best-grade loans.
We're not saying all of these will never cause losses, by the way. We have to assume losses will happen sometimes. But, over the medium-term, lending through a few of these, and splitting your money between hundreds of loans, is likely to give you satisfactory returns.
The rewards are good too!
This is rather like people who invest in the stock market through index trackers: the four-step strategy should lead the vast majority of individual lenders to a very attractive balance between risk and reward.
Not stock-market returns. But also not stock-market risks.
With simple lending strategies, it has been pretty easy for most lenders, even higher-rate taxpayers, to make real money over the past ten years, while lending through the safest P2P lending websites.
Looking at historical peer-to-peer lending returns you are likely to have earned far, far more interest than if you had stuck to savings accounts or cash ISAs.
Certainly, it would have been difficult for lenders adopting this four-step strategy to come out worse than if they'd just kept their money in savings – let alone to make a loss.
The rewards will vary in future, so keep an eye out that you're not chasing rates too low, especially compared to savings accounts.
This was part five of our ten-page P2P lending guide
- Read part four: The Five Key Risks In Peer-To-Peer Lending.
- Read part six: 10 Ways To Get Your P2P Lending Money Back!
- See the contents of the whole guide.
The opinions expressed are those of the author and not held by 4thWay. 4thWay is not regulated by the ESMA or the FCA, and does not provide personalised advice. The material is for general information and education purposes only and not intended to incite you to lend.
Experts, journalists and bloggers who conduct research and write articles for 4thWay are subject to 4thWay's Editorial Code of Practice. For more, please see 4thWay's terms and conditions.
The 4thWay® PLUS Ratings are calculations that were developed by professional risk modellers (someone who models risks for the banks), experienced investors and a debt specialist from one of the major consultancy firms. They measure the risks and rewards of losing money in scenarios up to a serious recession and a major property crash, and they assume you spread your money across lots of loans and rated P2P lending accounts or IFISAs. The rating is calculated using objective criteria that can be measured and improved on over time, although no rating system is perfect. Read more about the 4thWay® PLUS Ratings.