Alternative Investments – Peer-to-Peer Lending

Alternative Investments can provide lucrative returns that are unavailable by investing in the stock or bond market. In earlier posts, we discussed alternative investments in farmland, rooftop solar system, private equity, collectiblesreal estate, and gold. In this article we discuss investing in another form of alternative investment – Peer-to-Peer Lending, or P2P Lending or Crowd Lending as it is more commonly known. P2P Lending has gained plenty of momentum in the recent years as the hunt for alternative sources of investment and higher returns are pursued by investors, especially in this low interest rate environment.

Alternative Investments – Peer-to-Peer Lending

Peer-to-Peer Lending is the practice of lending money to unrelated individuals, or “peers”, without going through a traditional financial intermediary such as a bank or other traditional financial institution. The lending takes place online on peer-to-peer lending companies’ websites using various different lending platforms and credit checking tools. It is important to realize that these are unsecured personal loans – either to an individual or a small business.

The exact details may vary between platform to platform, but at a high level, the workings have three parties involved: borrower, lender, and the intermediary platform connecting the borrowers with lenders. The borrowers are willing to pay a high interest rate on the borrowed money which is passed onto the lenders, while the intermediary platform takes a cut for the service provided.

Each country has its own laws on whether P2P Lending is allowed and/or regulated. This wiki page lists some details for a few countries. One of the most popular platforms available to US citizens is Lending Club. Until very recently, Canada did not allow P2P lending unless the lender was an accredited investor but some new startups have started opening shop that individuals can participate in – such as Group Lend, and Lending Loop.

Investors can expect high returns between 5% and 15%.

My Thoughts

While the investment returns seem lucrative at 5-15%, the investment comes with immense amounts of risks. Let me count the ways.

  • You are lending money to an individual simply based on minimal amount of data – chances of default are very high!
  • Same goes for small businesses. Some websites simply present data posted by the marketing department which presents you with a very filtered view of the data.
  • If you are lending this to a small business – one has to ask the question why this business has had resort to this marketplace. Clearly the business has failed in raising money from traditional financial institutions such as banks or Business Development Companies (BDCs), who have more data on the business than you, as a private lender, do. Do you – as an individual investor have better evaluation of risk on these private closed-book businesses than banks or BDCs?

Im sure there are circumstances where such an investment would pay off, but the amount of risk is extremely high and potential investors should be willing to write off that investment if need be.

The big winner in this arrangement , of course, is the P2P Lending platform. The platform does not provide the funds risking capital and simply provides the service connecting lenders to borrowers and taking a cut.

So, am I saying that there is no way to get those kinds of returns? No. You can still invest in small businesses and get great returns in the range of 7-12%. And we simply turn back to our old friend – the stock market. Simply invest in the Business Development Companies. That’s what I did by investing in Main Street Capital (MAIN). BDCs are companies that have better view of the small businesses that are looking to raise cash and are better at evaluating the risk-reward profile than you, as an individual investor do. Couple of other huge advantages you can get by going this route – capital appreciation in addition to the dividends; and liquidity that you get from the stock market – you can simply liquidate your shares to get access to your cash if you change your mind about this investment. I shared some more of my thoughts on Private Equity and BDCs in this post here.

What are your thoughts on using P2P Lending platforms? Do you use it? Share your experience below.

Further Reading

Full Disclosure: Long MAIN. My full list of holdings is available here.

23 thoughts on “Alternative Investments – Peer-to-Peer Lending

  1. JC says:

    I wanted to get in on P2P lending but it wasn’t allowed in Texas so I wasn’t able to. I think it’s a decent place for some investment capital but like everything else there’s risks to it. I wouldn’t be a fan of lending to a small business through P2P for many of the reasons that you outlined. Frankly, there’s likely not enough information on the companies. I know others swear by P2P but for now I’ll hold off because there’s plenty of excellent blue chip companies to choose from. In the future I might revisit it but you’re right that the real place to invest in P2P are the trading platforms themselves. Got to love the toll road business model.

    • Thats too bad you dont have access to the market. I was interested in learning more about it when LC was becoming more and more common in the US and now that there are a couple of options here in Canada, I’ve given it a bit more thought and remain extremely skeptical. For now, I wont be touching this market as it does not justify my risk-reward profile and wanted to share my thoughts so ppl understand that high rewards come with high risk.

      Like you, I prefer the toll road business model more than anything else. A service fee for using all these services – passed onto the shareholders is just what I look for 🙂

      cheers
      R2R

  2. I’ve had several Estate Planning clients inquire about my thoughts on P2P lending, recently.
    I simply don’t like the business model in terms of risk vs reward as you pointed out, but I’m also extremely “pro dividend investing”.

    • Interesting to hear comments from the field. I think it really depends, just like any other form of investing – the risk appetite. It sure does not fit into mine and I will stick with dividend investing for a long time to come.

      R2R

  3. I’m a little more positive on the P2P lending idea than you are. I think the service fills a gap in the market place for individuals and businesses who can’t access traditional bank loans. In particular, it’s very hard for small businesses to access loans from traditional lenders. From an investor’s point of view, as long as you’re aware of the risks, do your best to mitigate them (demanding higher interest rates, diversifying your loans, ask for more info, etc.), and lend within your means…the reward might be worth the risk.

    • Hi DiH,
      Im sure the marketplace does fill a gap and exists for a reason. If every one of the borrowers was defaulting, the marketplace wouldnt exist at all. Like you said, the risk has to be understood and mitigated appropriately by each investor – and I remain skeptical. I wouldnt touch this with a 6 ft pole .. at not in my current situation. If I was more financially secure and was willing to take on more risks, I’d look into it.

      Best
      R2R

  4. I gave it some thoughts, but for now I’m not into P2P lending yet. The risk is still high as I see other bloggers eventually cashing out their positions. Only remain on P2P for advertisement purposes only.

  5. I love P2P lending even though I live and die by dividend growth investing more than anything else. This alternative investment is exactly that: an alternative investment. I would NEVER advise someone to put their entire net worth in P2P lending.

    I actually did a guest post on My Money Design a couple months ago where I went over some of the common arguments against P2P lending. Though I didn’t speak about business loans at all because the main platforms we have here in the US (Prosper and Lending Club) do loans with business as the purpose of the loan, but not actual business loans per se. I do, however, have a couple BDCs in my portfolio, including MAIN.

    I hope you don’t mind me posting the article in question: http://www.mymoneydesign.com/personal-finance-2/stocks/arguments-against-p2p-lending/

    Sincerely,
    ARB–Angry Retail Banker

    • Dont mind you sharing the post at all, ARB. Always good to hear the other side of the argument and learn about whats motivating ppl to go there and drive the growth in this business. You have a long article there, will be sure to check it out over the weekend.

      For sure the alternative investments should be exactly that – alternative. If ppl are willing to put some money into riskier plays for potentially good returns, it might be worth it. Im not sure if lending to individuals is any safer than small businesses. I personally would stay away from P2P lending – but maybe I will revisit in a couple of years if/when my financial situation changes.

      Best
      R2R

  6. R2R,

    I’m with you. I’ve taken a really good look at P2P lending and concluded it just wasn’t for me. I don’t see the need to stretch for it when high-quality dividend growth stocks should provide for ~10% returns over the long haul with plenty of income along the way, and with a lot less worry/headache. The tax implications also seem more complicated here and not as favorable for someone aiming to live off of that income at a young age.

    I think it’s really interesting. And it fills a need for sure. But I’d rather watch from the sidelines, where my capital isn’t at risk.

    Best regards!

    • Thats a really good point that I missed out on, in the article. The tax implications make it complicated and as I understand it, theres no way to shelter it from the high tax brackets. I guess it depends on each country and how the platform is structured, but for the most part, its a no-go for tax shelter.

      Im with you – really interesting to follow and learn about it, but rather watch from sidelines while enjoying safer investments in DGI stocks.

      Hope things are well…looking forward to see what you are doing with your site.
      R2R

  7. Nice article on P2P lending. I’d thought about it, but, I think that it does not appear to be that straight forward to me, first you need to find appropriate notes and there is a certain amount of capital risk, besides tax issues. For now, I’ll be happy with dividend investments but would keep watching it on the sidelines. Keep on racing!

    • Hi Race2Retirement,
      I completely agree there – definite a lot more riskier and other issues to consider before diving into this. Stock/Bond investing provides a lot more better opportunities and can be just as fruitful.

      Thanks for stopping by
      R2R

  8. I looked into this a little bit but found that there are a lot of regulations for Canadians that would prevent average investors like us to lend out money. It’s simply too complicated right now. I’d just stick with stocks.

  9. Glad to hear there are alternatives to Prosper and Lending Club for Canadians like Group Lend and Lending Group. Hopefully, the two mention keep big banks out of the game. For us, since big banks have gotten into investing in notes, there are few quality notes left for the little guys since like everything else, they get first pick. Money talks I guess.

    We still have money in both Prosper and Lending Club here in the US but are slowly getting out of P2P. We are hoping to funnel the money slowly into Loyal3 and build yet another dividend stocks portfolio. We love the Loyal3 model, the zero commission and the ability to invest with as little as $10.

    We may once again push to build our P2P account (if things ever improve), but for now, P2P has lost its luster to us.

    Thanks for sharing your article. AFFJ

    • Hi AFFJ,
      I noticed your post and was reading into it and looks like you had a thing going, but I have been in the camp where I’d rather invest that money into a company which has open books (public company), where theres enough history and I can read the financials and balance sheets to judge things instead of relying on a credit system for an individual.
      Good to hear that you are moving those funds to Loyal3…and thanks for sharing

      Best wishes
      R2R

  10. µin Belgium, we have little opportunity to do P2P lending. We do have some crowdfunding intitiatives where you can invest next to business angels/professionals in start up companies. At the beginning, I thought it would be a great way to diversify. I was dreaming of the having the next google or facebook in my portfolio – or at least, the thought crossed my mind…

    After 2 investments I decided to stop. The main reasons for me are
    1- illiquid investment. There is no secondary market. You need to look yourself for a way to sell to another person
    2- almost no updates after the investment. There is no obligation to communicate on the progress of the company. I guess, if I really want, I can reach out to them and request info. But it will not be as in depth as stock analyses you can read online

    AT

    • Thanks for sharing your experience, AT. I have look at similar platforms and even something like P2P or direct bond purchases – and the most important that stands out is taht lack of liquidity. If I need access to my money, there is no way to get it back. In some cases, there is a way to get it back but at a massive penalty, which completely stops me from using those vehicles as an investment potential. I will stick to the liquid markets 🙂

      Best wishes
      R2R

  11. Great blog you have here but I was curious about if you knew of any message boards that
    cover the same topics discussed here? I’d really like to
    be a part of group where I can get feedback from other
    knowledgeable people that share the same interest. If you
    have any recommendations, please let me know. Thanks!

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