Five Points to Keep in Mind When Investing in P2P Lending
Before investing in P2P lending, it is advisable to choose a lending platform after considering the track record of the leadership and their risk management team.
Peer-to-peer (P2P) lending may be the new kid on the block but it is already taking the Indian FinTech space by storm. It facilitates loans between individual lenders and borrowers through an online platform, in the process significantly reducing overheads traditionally associated with these transactions. As a result, borrowers benefit from interest rates much lower than those offered by banks or other traditional financial institutions, while lenders utilise their idle capital to earn higher returns than otherwise available in money markets.
Industry experts are hailing it as the investment trend to watch out for in 2017. The appeal of P2P lending for investors lies in the high ROI and predictable risk. A lucrative new avenue, P2P lending provides an opportunity to earn gross return of 22% to 26% per annum.
But while there has been a major change in the appetite for risk among Indians, P2P lending requires an investor to be thoroughly aware and educated on how to make informed choices when opting for P2P lending. P2P lending is globally growing at a CAGR of 48%. In India, the industry is expected to touch $5 billion by 2020-2021. It’s here to stay and the faster a smart investor understands, learns, and makes the most of it, higher the returns.
Let’s look at five integral points that investors must keep in mind before signing on as a lender with a P2P lending platform:
1. Build a Diversified Portfolio
Investments in P2P lending are similar to building a portfolio in any other market-linked investment opportunities. No one invests in just one stock. It’s always a mix of stocks – blue chip, large-cap, mid-cap, income stocks, cyclical stocks, defensive stocks etc. The idea is to not just hedge risk, but also return by putting money across various stocks thereby building a portfolio of high, low and medium return stocks. A similar approach should be adopted while building a portfolio in P2P lending.
Investors often tend to limit their investment to the same type of borrowers, loan amount, loan requirements, tenure, rate of return, etc. Investors with low risk appetite focus only on low risk borrowers and those looking for high gains focus only on high yield borrowers. However, low risk means low interest rates and high yield means high risk. Hence, the best approach to making greater returns is to build a diversified portfolio. Investments should be spread across different risk/yield categories, loan amount and tenure.
2. Small Ticket-size, More Loans
One of the biggest advantage of P2P lending is that the average ticket size can be as low as Rs. 1000/-. So invest small amounts in large numbers. And by that we don’t mean putting Rs. 2,50,000/- across 10 loans of Rs. 25,000/- each but to aim for 50 loans of Rs. 5,000/- each. Because this way even if a borrower does default the loss can be covered up by other investments on the platform. Managing 50 loan tickets may seem like a huge task. However, a good P2P lending will enable tech-based processes to help manage your portfolio efficiently. At Faircent, tech-enabled tracker provides updates on real-time basis thereby managing your portfolio for you.
3. Compounding Benefit
P2P lending is the only, unique asset class in which investors begin to receive returns - principal as well as interest - through EMI from the very next month of making the investment. Reinvest continuously to get the benefits of compounding interest and make higher returns. At Faircent.com, there has been a significant increase in reinvestment ratio with an increase in average EMI received ratio. This is primarily due to increased trust amongst the lenders on our platform.
4. Realistic Expectations, Long-term horizon
It’s important to understand that P2P lending is a risk-based market-linked investment opportunity that delivers high returns through careful, strategic planning and building of portfolio. An important trend that emerges from Faircent.com’s Research & Analysis Report April 2017 is that higher net returns correspond to greater investment amounts. Lenders investing more than 5 lacs on the platform are earning a risk-adjusted net return of approx. 20% against a lower though still robust 16% by lenders at investment levels of lower than a lakh. It is important to have a long-term horizon and to stay invested. Give it a three-year window. Factor in an average default-rate and calculate risk-adjusted annualized returns.
5. Informed Choices
Before investing in P2P lending, it is advisable to choose a lending platform after considering the track record of the leadership and their risk management team. You may even speak/write to the customer relationship officer or a risk management expert to understand the finer points of the P2P lending system and what kind of risk mitigation measures the company has in place. At Faircent, all data and statistics regarding loan returns, purpose, the average default ratio, etc. is published transparently on the website. We also provide quarterly Research & Analysis Report. All serious players with the aim to sustain in the market realise the importance of transparency in the system, as it plays a crucial role in building lender-confidence.
Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house
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