Bahaa Abdul Hussein gives an overview of P2P lending as an investment option with tips for including it in your strategy.

Due to low-interest rates, investors are searching for alternative strategies for growing their money outside traditional savings accounts and bonds. One option emerging for consideration is peer-to-peer (P2P) lending – adding P2P loans can give investors access to attractive returns while lowering overall risk.

What is P2P Lending?

P2P lending connects individual borrowers and investors through online platforms like LendingClub and Prosper. Borrowers apply for personal loans up to $40,000, and investors choose which loans to fund based on criteria like their credit score, debt-to-income ratio, loan purpose, etc. As the borrower repays his or her debt, principal, and interest payments come back into the investor’s account each month.

Potential Benefits of P2P Lending

  • Earn higher returns – P2P loans typically offer 5-7% returns compared to less than 1% on savings accounts and 2-3% on CDs and investment-grade bonds.
  • Diversify your portfolio – P2P loans provide exposure to consumer credit, an asset class that tends to be uncorrelated with stocks and bonds. This can help manage overall portfolio risk.
  • Shorter investment terms – Loans mature in 3-5 years, so your money isn’t locked up long-term.
  • Flexible investment amounts – You can deploy as little as $25 in a single loan. This allows easy portfolio diversification.

Risks to Consider

  • Limited liquidity – Loans are not readily sellable like stocks. You need to plan on holding them to maturity.
  • Higher default rates – Default rates of 5-7% are common. Diversification across many loans can help smooth out this risk.
  • Interest rate sensitivity – Returns may fluctuate with interest rate changes.
  • No FDIC insurance – P2P loans don’t come with the government backing of bank accounts. Due diligence on loan platforms is essential.

Tips for Integrating P2P Loans into Your Portfolio

  • Limit exposure to 10% or less of your total portfolio – This will minimize the impact P2P loans have on your overall returns.
  • Use an IRA account – This allows P2P returns to grow tax-deferred. Some platforms like LendingClub offer self-directed IRAs.
  • Automate investing – Set up automatic transfers from your bank account so loans stay diversified over time.
  • Focus on top-rated loans – A-C loans have lower default rates while offering attractive 5-6% returns.
  • Review late loans – Login regularly to watch for loans that are 15+ days late and intervene if needed by selling the loan.

The Bottom Line

Adding P2P lending to a well-diversified portfolio in moderation can enhance returns while providing exposure to consumer credit. Just be sure to understand the risks and implement prudent diversification, limits, and oversight practices. Used wisely, P2P lending can boost portfolio performance.

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