Peer-to-Peer Lending Vs Other Investments
This page was last updated on 16 June, 2018
In this article, we explain how peer-to-peer lending performs when compared against stocks and other investments. Here's a short summary:
ON THIS PAGE...
- 1. Peer-to-peer lending vs buying your own home
- 2. Peer-to-peer lending vs savings accounts
- 3. Peer-to-peer lending vs stock market index trackers
- Inflation-beating returns with lower risk over shorter periods
- Peer-to-peer lending vs the rest in the middle ground
- This was part seven of our ten-page P2P lending guide
- 1. Savings accounts, 2. peer-to-peer lending, 3. buying your own home and 4. the stock market are useful investments.
- Bonds and gold have been poor “middle ways” between savings and shares.
- Peer-to-peer lending has a better risk-reward profile.
A decade ago, when friends and family used to ask 4thWay founder Neil Faulkner for some tips on what to do with their spare savings and income, he used to suggest they get a mix of three savings and investments: savings accounts, buying a home and the stock market.
But peer-to-peer lending has long now been a standard fourth suggestion. (The 4thWay. Get it?)
The three other investments all serve a very useful purpose in a way that cannot easily be replicated with other investments. Let's look at those three before showing you why peer-to-peer lending now makes this key list of basic investments by comparing it to other investments:
1. Peer-to-peer lending vs buying your own home
Buying your own home will usually work out very well for you in the long run, provided your financial, home and work life is stable enough for that commitment.
You're replacing one never-ending, ever-rising bill – rent – with a bill that gets easier to pay as time goes by – a mortgage. This second bill should be over in about 25 to 30 years too.
Clearly, this is a very long-term goal requiring a lot of certainty in your life and financial position. You can't easily buy now down in Exeter and then decide to go for a new life in Edinburgh six months later.
2. Peer-to-peer lending vs savings accounts
It's not likely your savings will suddenly lose 15% of their value. This is why savings accounts have always been the place to keep money for emergencies. It's also why we use them to save for expenses that are coming up in the near future.
Savings accounts (including their tax-free equivalents, cash ISAs) can also make sense if you have a specific goal to save for over several years and you need certainty that the money will be there at the end.
As a complete contrast to other investments, the flipside with savings is that leaving substantial amounts in cash accounts over the medium or longer term is almost always very high risk!
We will probably continue to see the value of our savings absolutely smashed by the rising prices of goods and services we buy, because we won't earn enough interest to compensate. Our spending power goes right down.
3. Peer-to-peer lending vs stock market index trackers
The stock market has always been the place to invest if you want to have a good chance of beating rising prices over the long term.
They've also been one of the key places to look if you want to grow your wealth substantially.
Particularly investing regularly, as cheaply as possible, perhaps by spreading your money and risks between six to ten index trackers (and many hundreds of companies), is likely to reward you with satisfactory returns.
Unfortunately, most people don't do it this way. Yet, if you deviate from a simple and low-cost strategy like index tracking, you have both higher long-term risks and most people get far lower returns as well! It goes to show that higher risk does not always mean higher reward.
Even if you lend in index trackers, if you've ever seen stock-price charts, you'll know how bouncy the results can be. With short-term stock investing full of those risks, you must to be prepared to hold on for the long haul, if necessary.
The best research on share investing shows that not even the five years or 10 year-horizons that many fund managers espouse are sufficient for lowering the risk of disappointing and below-inflation stock-market returns; you need to be thinking about investing for 20 years to longer.*
Inflation-beating returns with lower risk over shorter periods
Before getting to the point about peer-to-peer lending vs other investments, and how it fits nicely in this middle ground between savings and the stock market, it's sensible for you to take a look at the middle-ground alternatives first.
Until peer-to-peer lending arose, there had been no satisfactory middle way between savings accounts and shares. That is, no investment offering to nicely counter inflation and perhaps earn a bit of a premium, but without risks that can force you to commit your money for a very long time.
Probably the two most used, or the most famous, ways are bonds and gold:
Bonds are usually considered the main “middle” way, but unfortunately bonds have a number of weaknesses that have revealed themselves in their disappointing results.
Bonds are a type of loan that investors make to governments or (usually large) companies. If you have a pension and you don't remember what you're invested in, you probably own some bonds through bond funds.
Bond funds have their moments of glory. But the rewards of investing in bonds have generally been low. Your chances of beating rising prices aren't a great deal better than savings accounts.
Even if you could invest in bonds at no cost, the best historical records* show that you could have invested regularly, month after month, with disappointing results. You could still very easily have found, after 20, 30 or more years, that your investments can buy you less in the shops than when you put the money in.
The reason was that, like savings accounts, shop prices rose too fast compared to your rewards from owning bonds.
And that's before deducting costs. After paying investing costs every year, bonds really start to look pretty ugly as a “middle way”.
If you're investing for incredibly long time periods, you should expect to get a decent premium above rising prices for locking your money up for so long. Yet bonds are not a good place to look for that.
In addition, if you're investing for shorter periods – say, 5 to 10 years – you have a real chance of losing more money when bonds fall. The roller-coaster isn't as severe as the stock market, but the chances of being less well off are higher.
Bonds really haven't lived up to expectations over much of the past 115 years.
Gold is a favoured place for dissatisfied investors to go to in a panic.
This is surprising to me, because this “precious” (but mostly useless) metal has a debatable record as a store of value. After the markup costs in purchasing and selling, not to mention possible storage and insurance costs, you'll be lucky to match rising prices over the long run.
In addition, the roller-coaster of up-and-down prices is as severe as the stock market. Possibly even more so, according to this New York Times article by N. Gregory Mankiw.
If you read that piece, remember that N. Gregory is referring to returns from gold before your investing costs are deducted. After costs, the results are even worse. N. Gregory also has a slightly different opinion to us on gold: he grudgingly suggests you might hold 2% of your spare money in gold.
So, with gold you're getting a lot of uncertainty and risk for very little long-term safety. The risk-reward profile compared to holding shares for the long term, frankly, sucks, and short- and medium-term gold investments are a huge risk due to its volatile price.
Peer-to-peer lending vs the rest in the middle ground
Peer-to-peer lending fills this gap in the middle that is not well serviced by savings accounts, the stock market, bonds, gold or any other investment.
It's why banks, hedge funds and other financial institutions are lending alongside us through the same websites and why financial advisers are beginning to advise clients to lend, too.
Bank lending, and now peer-to-peer lending, which is the same thing just done by individuals, has provided steady returns over shorter and longer time periods for a very long time. (At least, it has when banks have stuck to bread-and-butter lending rather than their subprime mortgage nonsense.)
This was part seven of our ten-page P2P lending guide
- Read part six: 10 Ways To Get Your P2P Lending Money Back!
- Read part eight: How Is Peer-to-Peer Lending Taxed?
- 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.
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*If you're looking for research on shares and how they compare to bonds and cash (savings), the best you can get comes from three London Business School professors, Paul Marsh, Elroy Dimson and Mike Staunton. They write the Credit Suisse Global Investment Returns Yearbooks and Sourcebooks, and are the authors of Triumph of the Optimists: 101 Years of Global Investment Returns.