How to make your P2P investments more profitable
Diversification
The most important thing is to diversify. Diversification can help you increase your odds of making a profit. If you are investing $5,000 or less then it is best to keep each loan at $25 (the minimum). You’ll have defaults over the course of your loan, and you will want to minimize the damage defaults can cause to your return. Do not make the peer-to-peer lending mistake that I did and spread your initial investment over a few loans. You will lose any chance of making a decent return if you invest only in a few loans. Funding Circle as well as Prosper offer automated plans which allow you to diversify your investment across many loans. Serious investors will look at each loan separately, which brings us on to our next point.
Select your loan carefully
If you’re looking for a return that is average, then automated investment plans are the way to go. Do not take this the wrong way. In today’s low interest rate environment, P2P lending is still a good investment. But if you are looking for a higher return, then you must be able to do better than the average. You need to examine each loan individually. It can be overwhelming to select from hundreds of loans. I suggest you start by narrowing down your selection using P2P loan filters. After you narrow down your choices, you can then read through the loan details to learn more about each borrower. Before making your final decision, you can ask the borrower a few questions.
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Most investments work immediately after you transfer your money. It is best to invest gradually in P2P lending. You may only have a few loans that you think are worthwhile if you follow point number two. If you have a limited amount of money to invest, I recommend investing a small amount in each loan (I suggest $25 or maximum 1% of your portfolio). Then wait a couple of days for more loans. Repeat the process. You may need to wait several weeks before you can invest all of your money, but you will end up with a portfolio that performs well.
Choose longer-term loans
We don’t do this, but we offer longer-term loans with an additional 2-3% in interest rate. I have found that defaults are more common in the early stages of the loan lifecycle. Therefore, I would expect the default rate to be slightly higher than the three-year loans. The higher interest rate gives you more flexibility if the defaults are slightly more. These five-year loans are new so it is not guaranteed that they will perform better over time. If you carefully choose your loans, and limit your chances of default, then the additional 2-3% of risk is worth it.
Reinvest interest payments
After you invest in loans, you will receive payments on your account in 30 to 45 days. The cash in your account will earn 0% interest up until you invest in new loans. You can start investing your money as soon as you reach $25. This can happen very quickly depending on the balance of your account. A $10,000 loan portfolio will give you enough money to invest in 2 or 3 new loans each week. Remember that with P2P loans, you get interest and principal payments on each loan every single month.
Bottom line
A final tip that will make you a better investor. Do not rely on Funding Circle’s or Prosper’s ROI figures. Calculate your P2P Lending ROI by yourself. It is important to note that both companies will overstate the actual return. To find out the true number, you can use a simple Excel sheet and the XIRR() formula.
P2P lending is attractive to many investors because it promises high returns. However, few take the time to learn how to maximize those returns. It is likely that if you follow these five key principles, you will be a successful investor in P2P lending with returns above average.
Peter Renton is the editor of Social Lending Network. This blog is dedicated to peer-to-peer lending.
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