There is no such thing as a risk-free investment . When making any investment you need to be aware of all the risks involved and place them in the right context.

Let’s talk about the risks associated with P2P investments.

This type of debt investment has existed for many years. It was only recently that this type of debt investing became available to retail investors.

Recently, I attended the peer to peer investment conference LendIt in NYC. The conference was informative and included some interesting developments within the P2P sector.

When I started investing in P2P, there were only retail investors. Peter Renton, Lend Academy reports that only 15% of attendees were retail investors; the remainder were institutional. It speaks volumes that professional investors are involved. But I digress…

Todd’s argument for P2P investment goes like this:

Mathematical expectancy is the key to determining your investment return. [This can be understood simply as probability x payout]. Expectancy = (Gain from a Winning Bet + Probability to Win em>) + (Loss from a Losing Bet x Probability to Lose em>

The problems of peer-to-peer loans are instantly apparent when viewed through this lens:

• You can lose 100% of your investment, while you only gain the interest rate. This creates a negative ratio between risk and reward.
• The system is still too new to be adequately stressed tested, so it is impossible to determine your probability of loss or gain.

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Todd’s article focuses on two main issues: default risk and interest rates risk.

Default risk

Let me now discuss the first of these points. This statement is true for any fixed-income investments. I don’t think I understand his reasoning for claiming that this argument was exclusive to P2P investments.

I don’t think you can ever lose 100% of your deposit if you are investing in hundreds of bills. This would mean that every note you invested would default.

The second issue is also true if you refer to the data from Lending Club and Prosper, but it has a much longer documented history that shows P2P investment is the exact same class of investments. This comparison doesn’t include high-yielding bonds.

Both companies offer credit that is unsecured for a maximum of five years. Lending Club and Prosper notes are nearly identical to unsecured revolving credit cards offered commercially by banks.

I only invest in borrowers consolidating their debt or who get a better interest rate on credit cards. We can all agree that a comparison of default rates on credit cards is a good way to judge.

The Federal Reserve has data on credit card default rates. Federal Reserve data goes back to 1985.

Three recessions have occurred in the last 20 years. The readers will agree that 2008 was the worst year since the Great Depression. Since 1985, credit card default rates have averaged 4,7%. In the fourth quarter 2010, the default rate reached a peak of 10.59%. In the recession that preceded it, the default rate reached as high as 7.79%.

My default rate has been slightly above 3% in my anecdotal five-year experience of Lending Club. The Federal Reserve has averages for unsecured debt.

Based on these data, it’s more than possible to get positive returns using Lending Club and Prosper. This statement is also supported by Lending Club data from this time period (Prosper used a different model of lending at that time). The returns are still positive when you pool all Lending Club notes from this time period. If we have another severe recession, your returns will still be decent.

Todd’s article does not agree with my findings.

Interest rate Risk

The difference between 10-year Treasury notes and credit card rates is currently huge — approximately 1,300 basis points at the time this article was written. While slightly lower than credit cards rates, P2P rates still offer an attractive rate of return to investors.

Even if interest rates rise in the future, unsecured credit card debts will still be a good investment. Interest rate risk doesn’t become a concern with P2P investments until the Federal Funds Rate is much higher, say 5% or more.

Comparing P2P investments to other fixed income investments, they should continue to be attractive for the foreseeable.

Since 1994, the average rate of interest has only decreased by 700 basis points. Even in this low-rate environment, credit card interest rates remain stubbornly high.

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Credit card rates have barely changed during the low Federal Funds rate period due to the Dodd Frank regulation and a heavily regulated banking sector. $850 Billion in outstanding revolving credit is a large amount of debt that individuals have to consolidate and reduce.

Individuals are refinancing their high interest rates into something lower. Lending Club, Prosper and other P2P firms are ideal candidates to exploit this gap.

This is a great opportunity for P2P investors to profit from the interest rate difference and assist borrowers in obtaining a lower rate, while also generating a steady income on their P2P investments.

Is P2P investing risky?

These counterpoints don’t eliminate all the risks associated with investing in P2P.

Retail investors are now able to invest in this asset class. However, commercial banks have had access to it for years. Retail investors could only buy into this asset class indirectly by owning bank stocks.

Now, P2P investments bypass the middleman.

The only articles I have seen that are negative about P2P investments come from people who do not have direct investing experience. I have been investing in P2P for over five years with Lending Club and can offer some insights into the space.

P2P investing has its own risks and is not perfect. However, it is an investment worth seriously considering. I’ll go so far as to say that P2P investment is safer than other high-yielding fixed-income investments.

For the moment, I will invest in Lending Club notes and Prosper until other fixed rate investments become more appealing.

With the Federal Reserve’s commitment to continue pumping liquidity in the market, it could be years before the situation changes.

The P2P investment model is currently the best option for investors looking to earn high returns, with low risk, and low-duration investments.