In the fall of 2015, MonJa launched our blog series “5 Common Mistakes P2P Loan Investors Make.” We’ve delved into the following 4 potential shortcomings that can happen to investors- insufficient diversification, using simple filters, investing in a single platform, and investing in only high interest loans. In our fifth and final piece, we explore what happens when investors invest only in low interest loans. These observations aim to help investors understand essential investment strategies. Our team would love to hear any thoughts or feedback on this series- email [email protected] to start the conversation.
Most yield-hungry investors are attracted to marketplace lending because it offers higher net returns and lower risk than traditional fixed-income securities. According to an article by Crowdfund Insider, some funds obtain net-returns that average about 10%.¹
However, an investor searching for a net-return of 10% needs to select loans with higher interest rates to reach that target. This means that the investor should not invest in only high-grade, low-risk loans.
Depending on your risk tolerance, you can choose how to allocate the capital. Most banks are highly regulated, so they have a lower appetite for risk. On the other hand, funds have a higher risk tolerance, so they would diversify their portfolio with loans across a spectrum of different interest rates and asset types to hedge their bets. For conservative investors who are purchasing only Grade A and B loans, consider the extra premium paid for investing in lower risk loans. Especially during times of interest rates rising, this aversion to risk can potentially have adverse effects on your portfolio.
Another factor to consider when evaluating the performance of your portfolio is to determine how well the returns compensate for the risk taken. On our last blog post, we discussed about investing in only high interest rate loans. As an investor one question to ask is whether or not investing in riskier loans is worth the additional return. If your target return is 9%, would taking the extra credit risk premium to invest in Grade E loans be worth it? Under a recession, you might experience some difficulty in reaching your target return, but it’s still higher than investing in only Grade AA loans and gaining only a 5% return.