[Please welcome our first guest poster, Alex! Alex is on a journey of growth and life purpose. He has spent the last 3 years learning everything he can about investing for millennials and personal growth. He blogs over at growthandpurpose.com about this through wealth creation journey. Thank you for being a Duke!]
What is your risk tolerance?
If it’s moderate to high, I would love to share something with you that I think you will find interesting. This isn’t a get quick rich scheme and it does involve some time, energy and of course capital. But over the last 2 years, I have had a lot of fun learning about this strategy and the best part is I have made nearly 8% return on my investment.
In this post, I want to describe to you what this investment strategy is, how it works, and the benefits and risks involved with getting involved with it.
My goal for you is to learn something new and to be interested enough to try this investment strategy out.
Ready to dive in?
What is peer to peer lending?
I will stop being secretive and tell you what type of investment this is right now…it’s peer to peer lending.
No, I am not talking about bitcoin.
At its core peer-to-peer lending (P2P lending), is the practice of lending money to individuals or businesses through online services that match lenders with borrowers.
It is really as simple as that. One of the reasons why I love this strategy so much is that as the investor you get to act like the bank. As the famous saying goes, “those who understand interest earn it, those who don’t, pay it!”. A P2P lending platform allows you to earn interest on the money you lend to the borrowers plus receive your principal payment back.
How does peer to peer lending work?
It truly is supply and demand at its finest.
There are two major platforms that borrowers and investors visit to engage in peer to peer lending, they are Prosper.com and Lendingclub.com
Each platform attracts borrowers (the supply side of the equation) and investors (the demand side of the equation).
In the middle, you have the platform that performs basic underwriting and the collection of money (for a small 1% fee).
It’s an amazing blend of active and passive investing. It’s active because you can pick exactly who you would like to lend your money (you don’t actually see their name but rather their risk profile and public debt information) and passive because you don’t have to collect the money. The platform does that for you and puts it in your account.
How risky is this peer to peer lending strategy?
I mentioned risk at the start of this post so I think it’s time we address it. These loans are unsecured debt. What that means is that there are no assets backing up these loans.
If someone decides to stop paying on the loan they aren’t going to get their house foreclosed on or their car repossessed. Yes, they will take a hit on their credit score and a stain will go on their permanent record but that is about it.
There are of course ways to mitigate the risk (or it would be a really bad investment).
You can fund a part of a loan request for as little as $25. This allows you to spread out the risk of default by having $1,000 into 40 different loans. Your odds of everyone defaulting (if you are investing in creditworthy debtors is lowered).
The other way to mitigate risk is to sell an underperforming note (fancy name for the loan agreement you have with the borrower) on a secondary market. If the loan is only a couple bucks I will put it on the secondary market but I won’t lose sleep over it.
How does this strategy fit in with my other investing strategies?
To be 100% honest with you, this isn’t my first, second, or third investing option. I have a much larger amount of my investments in more traditional methods like a 401k, a Roth IRA, and selective ETFs and stocks in my Robinhood account.
So why do I even bother with peer to peer lending?
For one thing, I think it is a great way to educate yourself on what goes into a loan (credit scores, amount delinquent, debt to asset ratio, etc.). It puts you in the mindset of looking for ways to actively seek a return on your investment.
I might fund a couple AA and B loans to see what type of return I can get on my $100.
Why you should consider peer to peer lending
You genuinely help people.
One aspect of peer to peer lending that isn’t often talked about is that you are genuinely helping people. They are coming to the lending platform to consolidate credit, to pay for an unexpected medical bill, or a variety of other reasons.
If you have some extra money that you can lend for 3 to 5 years (the two options for most of these platforms) you can help someone and see a return on your investment.
You are increasing your investment knowledge
I think you should always know what is out there in the market for investing strategies. Even if you decide peer to peer lending isn’t for you it’s still a good idea to understand how it works and the pros and cons of this strategy.
It’s no secret interest rates are rising
With rising interest rates it will mean money isn’t as cheap to borrow as it once was. I am not 100% sure how that affects peer to peer lending, perhaps pushing some of the safer loans out of the market. But you can be sure that peer to peer lending will be affected. The more you can educate yourself on this investing strategy now the better prepared you will be in the future.
It would seem that banks do well when interest rates are going up and you will remember I said you get to act like the bank with peer to peer lending.
Wrapping it up
If this investing strategy is new and interesting to you I have good news and bad news.
The good news is that there is no better time to start investing and learning about peer to peer lending. There are still plenty of loans on the marketplaces that need investors funds.
The bad news is there is a lot more you still need to learn and understand. I simply cannot fit it all into one post. Take the first step in your investing knowledge and start reading other blogs about peer to peer lending.
All in all, I love peer to peer lending. I think it’s the millennial in me. It’s the perfect combination of technology, investing, and community. I typically only put a couple hundred dollars a month in Prosper.com (my preferred platform) and enjoy seeing my money grow.