Your Investment Portfolio: Should Peer-to-Peer Loans Be Part Of Your Investment Strategy?

Many investors have learned how tumultuous the stock market can be over the last 24 months and are looking to add alternative investments as part of their portfolios to bring added diversification and hedge against the volatility in the stock market. Many investors are moving a portion of their funds into other asset classes such as bonds, real-estate, precious metals and cash investments.

Gold has been the most popular alternative investment by far during the last 18 months. With fears of inflation on the way, many investors are trying to protect their assets by putting a significant portion of their assets in gold. The belief is that gold will have the same value regardless of when currencies rise and fall. Unfortunately, all of the demand from investors have driven up the price of gold in the last 12 months and its at a near all time high. Some believe gold has some room for growth, but most analysts believe that it’s probably not the best alternative investment.

Another alternative investment that many are looking to is peer-to-peer lending. Some consider the idea of peer-to-peer lending a new investment, but it’s actually older than just about any investment–loaning money to other people. In recent years, we have shied away from making personal loans to other people because of the risks associated. Previously, there were no real consequences for borrowers that did not repay their loans and too much risk from loaning money to an individual.

Peer-to-peer lending companies Prosper Marketplace and Lending Club have found a way to allow individuals to lend each other money without the downfalls of loaning a friend money. First, you’re loaning money to dozens of different people, so your risk from lending money to one borrower that doesn’t repay is minimized significantly. Secondly, both companies have collections practices and report to credit bureaus. If a borrower does not repay their loan, it will be reflected on their credit report and the companies will instigate multi-faceted collections efforts. There are still borrowers that won’t repay, but collections calls and hits to one’s credit score provides enough of an encouragement for most borrowers to repay their loans.

Some will debate the rates of return that investors can get from peer-to-peer lending companies, but the general consensus is that many lenders are earning between 7%  and 12% on their investments. Lending Club advertises that its lenders are earning a 9.5% rate of return on their funds and Prosper Marketplace advertises that its investors earn between 6%-14%.

When you invest money into a peer-to-peer loan, you will receive your money back plus interest over a 36 month period. You will periodically need to re-invest some of your funds in new loans as you receive payments from your borrowers.

Peer-to-peer lending has aspects of a fixed investment, but it’s very different than other asset classes. Performance of peer-to-peer loans has generally been independent of market conditions as well. If you can find good loans to invest in, you can make reasonably good rates of return that are relatively independent of the performance of the stock market. However, like any investment, there are risks involved.