Guide
Investing: what P2P lending is and is not good for
This blog started because savings rates were near zero and peer to peer lending looked like the obvious answer. Rates are not near zero any more, which changes the question entirely, and it is worth being honest about where lending to small borrowers sits next to the alternatives.
What it competes with
Cash. Protected by the Financial Services Compensation Scheme up to 85,000 pounds per institution, available on demand, and for most of the last three years paying a rate that a 2016 peer to peer investor would have found astonishing. Cash is the benchmark, and the gap between the best easy-access account and a peer to peer target rate is the entire compensation you are being offered for illiquidity, default risk and platform risk.
Gilts and investment grade bonds. Lending to the government or to large companies, priced daily, sellable any morning. A gilt held to maturity has a known outcome. A development loan does not.
Index funds. Volatile, occasionally frightening, and liquid every trading day. Over long periods a diversified equity fund has beaten almost everything else, and the reason people reach past it is that the volatility is visible in a way that credit risk is not. A loan book shows a steady 8 per cent right up until the month it shows minus 40.
That last point is the one worth sitting with. Peer to peer lending does not have less risk than equities. It has less visible risk, until the moment it has all of it at once.
What it is genuinely good for
Income with a known schedule, in normal conditions. A book of loans paying monthly interest produces a predictable stream in a way an equity fund does not.
Diversification away from listed markets, up to a point. Small property loans are not driven by the same things as global equities. They are, however, driven very hard by UK property prices and by interest rates, so a portfolio of UK property lending plus a UK buy to let is far less diversified than it looks.
A small, deliberate allocation for somebody who enjoys reading loan documents and can leave the money alone for years. That is a real use case. It is not a large one.
The mistakes that cost most
Treating the advertised rate as the expected return. It is a target before losses. The number that matters is what you got after defaults and after recovery, and on most books that was materially lower.
Chasing the highest rate. The highest rate on offer is the market's opinion of who is most likely not to pay you back. In 2017 the platforms advertising 12 per cent were disproportionately the ones that failed.
Assuming you can get out. A secondary market is not liquidity. It is other lenders being willing to buy, and they stop being willing at exactly the moment you want to sell.
Under-diversifying across platforms. Spreading across two hundred loans on one platform does nothing about platform failure, which is the risk that actually destroyed capital.
Confusing regulation with protection. Every platform that failed was authorised by the FCA at the time.
Reinvesting automatically without reading anything. Auto-invest tools were excellent at deploying money into a deteriorating loan book faster than a human would have.
An order of operations that has aged well
- Emergency cash, in an account you can reach the same day.
- Pay off anything costing more than you can reliably earn.
- Pension contributions, for the tax relief, which beats almost any investment return available anywhere.
- A diversified, low cost equity and bond portfolio inside an ISA.
- Anything more exotic, with money you can afford to lose entirely and leave untouched for years.
Peer to peer lending is step five. It was sold in 2016 as a replacement for step one, and that framing is what did the damage.