The P2P lending market grew at a rate of 25% between 2014-2019 and is expected to remain a popular investment option for investors who want to diversify their portfolios. P2P, which is a kind of lending that is done online through the use of an online platform instead of a financial institution, has many benefits to offer both investors and borrowers. Before investing in P2P however, investors need to have the right information at their fingertips in order to maximize their investments and reduce their risk of losing money.
What is P2P Lending?
P2P is a form of lending that involves borrowers who are seeking unsecured, personal, or business loans and lenders who want to make a higher than usual return. The lending is done on several online platforms which help to screen potential borrowers, mitigate risk, facilitate the transactions, and collect money on behalf of investors. P2P lending is a safe and efficient way for borrowers who cannot access funds via traditional channels to get the funds that they need. It is also great for investors who want to get high returns and get their money back quickly.
P2P lending will continue to grow and become the lending vehicle of choice for many people who are shut out of traditional financial channels such as banks. Further, the proliferation of SME’s that require alternative financing, quick loan processing, and negotiable repayment terms mean that P2P lending will remain a popular option for investors. Finally, the COVID-19 pandemic has had a positive effect on alternative lending as lenders and borrowers do not need to visit physical premises and can simply carry out their transactions online.
Advantages of P2P lending:
Thanks to the fact that it is conducted purely online, P2P has several advantages for investors:
1. Quick processing
Lending on P2P platforms is highly automated, which means that investors are quickly matched with borrowers so they can earn interest on money consistently. In addition, since everything is done online, there is no need for piles of documentation that must be approved and signed by several people in the chain of command before funds are disbursed. This makes your money available to borrowers quicker and ensures that you get your returns as quickly as possible.
P2P lending allows you to diversify your portfolio so that you do not put all your eggs in one basket by investing too heavily in one company or sector. This means that you can spread your risk and protect your money from systemic risks such as inflation, change in interest rates, and natural disasters. Diversifying your portfolio also allows you to maximize your returns by investing in areas like P2P lending which offers high returns.
3. High returns
Due to the fact that P2P lending mainly targets borrowers who cannot access regular financing, it tends to have higher interest rates in order to cover investors. As a result, investors can expect to earn between 6% and 36% depending on the platform they choose. In addition, investors can choose platforms that offer the highest interest rates or invest in a mix of platforms in order to maximize returns.
Disadvantages of P2P lending:
Even though it has some major advantages, P2P lending does have a few drawbacks vs bonds. These include:
1. High risk
P2P lending targets borrowers who are considered high risk by traditional lending channels. This means that their risk of default is very high. To mitigate this, online lending platforms charge borrowers a higher-than-average interest rate so that they get the bulk of their money back even if the borrower defaults on the loan.
2. No protection
Investments like shares and bonds offer some measure of protection to investors to ensure that they get their money back even if the economy performs badly. This protection comes in the form of insurance and investment legislation. Due to its high-risk nature, P2P does not qualify for these types of protection.
What are bonds?
Bonds are long-term debt that pays interest on the initial investment at a predetermined rate. They allow governments and corporations to fund projects by borrowing from the public and paying back the amounts borrowed with interest. Investors have a wide variety of bonds to choose from including government, corporate, municipal, and callable bonds.
Government bonds are among the safest bonds as they are always paid back unless a country goes bankrupt or goes into war. Corporate bonds have a shorter maturation rate than government bonds and are pegged on the success of the company. They also provide higher yields than government bonds and can be recouped in a shorter time period.
Municipal bonds are issued by local governments in order to fund infrastructure and other projects. They are great for investors who are looking for a tax incentive.
Callable bonds are a type of bond that can be recalled before the maturation date. Investors usually invest in this type of bond to earn a little interest on their investment before market conditions improve and they can put their money into a more favorable investment.
Advantages of bonds:
Bonds have a number of advantages that make them a desirable investment:
Because they are issued by governments or established corporate, bonds are less risky than many other investments in the market. This is especially so because they are a debt that must be paid before other obligations. Further, because they are issued at a lower interest rate than other investments, they are more likely to be paid than options like stocks, annuities, or options.
In addition, bondholders have an advantage over share or stockholders in the event that if a company goes bankrupt, bondholders get paid first. Even if there is very little money after a bankruptcy declaration, bondholders will still get some of their investment back while shareholders might lose everything.
Bonds are also considered risk-free because the government or other issuing body must pay your money back even if there is inflation or other events that affect the value of your investment.
If the economy is performing well, then stocks will tend to outperform bonds and other investment options. However, it is not unusual for stocks to lose a significant portion of their value in a bad economy. This can be difficult, especially for older investors who retire on the stability of the market in order to support themselves.
If you are older or would like your portfolio to retain its value in the long term, you are better off investing in bonds since you are assured that your investment will retain its value and that you will get a return even if the economy performs badly.
3. Perform better in the long term
If you are saving for a future expense such as a mortgage or college fund, you are better off choosing an investment that retains its value and pays an interest regardless of how poorly the economy performs. Major expenses like mortgages and college funds should not be subjected to volatile investments that can cause them to lose their value. Bonds are therefore the best investment as they will ensure that, at the very least; your investment retains its value and that you earn interest on whatever amount you have invested.
Disadvantages of bonds:
While bonds do have a place in your investment portfolio, they do have several disadvantages which include:
1. Reduced returns
Due to their conservative nature, bonds give you a very low return (sometimes as low as 1.7% p.a) which might not seem like a fair return especially if you have invested a lot of money.
2. Higher investments
Due to their low rate of return, bonds may require that you spend a significant amount of money so that you can make good returns. This may end up shutting out investors who do not have large sums or those who are just starting out.
P2P lending vs bonds – which is better?
There are several factors to consider when deciding between investing in P2P lending or bonds:
- Amount: if you have a large amount of money at your disposal, you can choose to invest in both P2P lending and bonds in order to maximize your returns.
- Age: Your age does play a role in the type of investment to choose. If you are young, you can get away with choosing a high-risk and high-return investment like P2P lending. If you are older, however, it might be better to go for a lower-risk investment like bonds so you do not risk your retirement funds.
- Goals: goals will also influence the type of investment you choose. if you want to multiply quickly but run a high risk of loss, you can choose P2P lending. If your goal is to safeguard your money but earn very little returns, you are better off choosing bonds.
Investing in P2P lending vs bonds comes down to individual choice. As long as you decide your investment goals before you make your choice, you will be able to choose the right investment vehicle for you.