I have been wondering lately if there are some best practices for investors when it comes to p2p lending. These would be tried and true ideas that apply to investors whether it be in Lending Club, Prosper, even Zopa (in the UK) or any new entrant that might come into the industry.
Open any finance magazine or talk to any financial advisor and you will hear about all kinds of best practices for investing in various different asset clases. I think peer to peer lending also has some best practices and I share a few thoughts about this topic below.
1. Diversification
This is the most important factor in the success of your p2p investment. Regular readers will have heard me say this many times. You need to diversify your investment. If you invest $1,000 make sure you invest in the minimum of $25 per note. I really think unless you are investing more than $5,000 it is important to stick to the $25 per note minimum. Defaults are a fact of life in p2p lending – if you invest long enough you will eventually suffer defaults so you want these defaults to impact your overall investment as little as possible.
2. Don’t let idle cash build up
One of things that sometimes surprises new investors is how quickly the cash builds up. Once you start investing in loans within 45 days you will see payments coming into your account. These payments consist of principal plus interest so with a fully invested $10,000 account, for example, you can see new cash coming in at the rate of $400-$500 per month depending on the terms of your notes. This cash will sit there earning 0% interest until you reinvest.
3. Understand the risks
There are detailed prospectuses available for both Lending Club and Prosper (those are links to the current prospectus PDF files). They contain all kinds of information including around 20 pages detailing the risks of p2p lending. Now, I realize that few investors will read these before investing (I know I didn’t) but it is still important to have some idea of the risks. I wrote a post a few months ago detailing some of these risks and if investors don’t want to read the prospectus they should at least spend a couple of minutes reading that post. There are also some great comments there which will give investors even more information.
4. Do Some Research
This one is pretty broad. But I think investors should at least do some research before committing their money. I would like to see every investor spend an hour or more looking at the investor information on the websites of Lending Club and Prosper or spending some time doing analysis on Lendstats or Nickel Steamroller. This way you can get some idea of how the system works and what kinds of loans are more likely to produce good returns.
Those are the main ideas I have but I wanted to open this issue up to others. I created this post as a question deliberately because I don’t think best practices in p2p lending have been fully defined yet. What do you think are some best practices that would apply for all p2p investors? Please share your thoughts in the comments.
