The 10 most importants points when investing into peer-to-peer loans

Disclosure: This site may contain affiliate links, meaning, at no additional cost to you, we will earn a commission if you decide to make a purchase through our links. Please read our data protection statement for more information.

Reza Machdi-Ghazvini,CAIA
Last updated on 04 September 2021

The 10 most importants points when investing peer to peer loans

You are interested in investing money and came across the possibility of investing in P2P loans? In short, you are interested in so-called peer-to-peer loans? Then you should definitely consider the following 10 points to invest successfully in P2P loans.

1. P2P loans are a risky asset class

As with any other investment, you should first get a clear picture of the risks involved. P2P loans involve lending money to real private individuals. Instead of a bank, many other users on a P2P platform lend money to private individuals. Private individuals can get into payment difficulties, which can lead to delays and defaults on loans.

P2P loans are associated with risks for you as an investor.

Incorrectly, P2P loans are often compared with classic financial products such as overnight deposits. The risks for P2P loans and overnight deposits are in no way comparable, and you should only invest a small percentage, for example 5% - 10%, in P2P loans.

2. Don't invest your nest egg in P2P loans

P2P loans are a risky asset class, so you should never invest your nest egg in P2P loans. Besides the risk of loan defaults, P2P loans also have the disadvantage that your money is not available on a daily basis. You do not have immediate access to your nest egg, which is exactly what it is meant for.

You should rather invest your nest egg in safe investments such as call money or savings accounts. The deposit protection protects your capital up to €100,000, and you have daily access to your nest egg.

3. Invest without emotions in P2P loans

Emotions can be a hindrance when investing in peer-to-peer loans. For example, if you look at the returns every day and discover major changes within your investments that worry you, it can quickly unsettle you and take you away from your goal.

The magic triangle of investing best illustrates the trade-off between returns, safety and availability. In the case of P2P lending, the magic triangle can be applied as follows:

Higher returns and longer maturities lead to higher risk and lower availability of money.

Therefore, always keep your investment goal in mind and do not let your current mood guide you. The same applies to the reverse case, you should take sober note of an above-average development of your investments.

4. Spread your capital over as many P2P platforms as possible

The risk of investing in P2P loans should be reduced by choosing several reputable P2P platforms. Spreading your capital across different platforms is a critical point in minimizing risk.

If you choose a P2P platform, we recommend you to pay attention to a positive track record and availability of data, among other things. Another important point is how long the platform has been around. You will find that many P2P providers have not been on the market for very long. So, the providers have not yet been able to prove their handling of crises.

This makes it very difficult for you to judge how crisis-proof individual platform are. The insolvencies of the P2P platforms Grupeer, Kuetzahl and Envestio have shown how important it is that you spread your capital over as many P2P platforms as possible.

You should spread your capital at least over 3 platform and in the best case over 5 - 8 providers. 

5. Spread your investments over many P2P loans

To further reduce the risks of P2P lending, spreading your investment over several P2P loans is mandatory. The following applies: Do not overdo it. A good guideline is the minimum amount that the platforms require for investments per loan.

For example, if you want to invest €300 and the minimum amount is €10, you have the opportunity to invest in 30 loans. If one loan defaults, the remaining loans can make up for the default.

6. Don't invest everything immediately at the beginning

Once you have found the right platform for you and determined your investment amount, take your time.

Familiarize yourself with the platform of your choice and initially invest 20% - 30% of the planned investment amount. In this way, you will gain initial experience and become more confident in using the platform.

7. Invest rationally and prudently

Remember the magic triangle of investing and don't panic if some of your loans are in default.

This is part of it. If you have set your investment strategy at the beginning and invested in loans based on it, you should stick to your investment strategy.

However, if your returns are consistently below average, you need to rethink your investment strategy.

8. Don't leave money in the central account of the platform

You might be wondering why you should not leave money in the platform's central account? Simple. In addition to the credit default risk of your loans, you also need to consider the platform risk. This is the risk that a P2P platform can go bankrupt.

If one of the platforms on which you invest in P2P loans goes bankrupt, your money is probably almost certainly gone because there is no deposit insurance.

An insolvency administrator will try to compensate the investors for their claims from open loans, but we would not rely on that. Therefore, you should make sure not to leave any money on the central account of the platform.

9. Use the automatic investment function

To invest successfully in P2P loans in the medium to long term, you need to spread your investments over as many P2P loans as possible. The best way to achieve maximum diversification is to use the automatic investment function, which is now offered by almost all P2P platforms.

Manual selection of P2P loans is not recommended, as you would have to analyze hundreds of loans individually. Moreover, you are disadvantaged compared to other investors who invest automatically. You would have to select loans faster than the computer, which is hardly possible.

10. Be patient

One of the most important qualities you should bring to the P2P asset class is patience.

You must realize that you cannot get rich overnight with P2P lending. You should invest in P2P loans as banks lend: Steer your focus on loans with yields and maturities in the middle range and don't get seduced by high yields.

Because that's how banks make their money in lending in the medium and long term. They have understood that when it comes to loans, it is important to achieve sustainable returns in the long term instead of taking big adventures.

Conclusion

Successful investors in P2P loans have understood early on that they must not let themselves be led by their emotions when it comes to P2P lending and must consciously keep an eye on the risks.

If you stick to the 10 points presented, you should be in a good position to invest sustainably and successfully in P2P loans.