5 Common Misconceptions About Investing in Peer Lending

Peer lending has been around for over a decade (Zopa launched in UK in 2005). Despite this history, there are still many misconceptions about investing within this relatively new asset class. Here are a few of the most common ones:

1) Peer Lending is unregulated

Belief

As an example of “shadow banking,” Peer Lending is an unregulated industry that offers little protection to investors. This is illustrated by the Ezubao scandal: a Chinese peer lending platform that scammed 900,000 investors out of $7.6 billion dollars.

Reality

While peer lending may exist in a grey area in other countries, in the United States peer loans are considered securities and therefore benefit (or suffer, depending on one’s point of view!) from many governmental rules. In particular, investments made by retail investors are strictly regulated, and all assets must be held by independent, qualified custodians.

2) Peer Lending is too new to prove its value

Belief

Peer lending has only existed for a few years, which means that overall asset performance is largely unproven. How the asset will perform during a crisis is completely unknown.

Reality

Performance data is publicly disclosed and readily available for the more than one million loans that have been issued through peer lending. This includes loans that were issued during the Great Recession. During this time, investments in peer lending lost 3% (compared to -57% for the stock market).

Moreover, three-quarters of the issued consumer loans are used not as a method to finance more obligations, but to consolidate existing credit card and revolving credit debt. This means that peer lending is being used as an alternative to banking, one of the most profitable industries in the last 50 years.

3) Peer Lending is a non-liquid asset

Belief

Investments are tied up for long period of time. If borrower payments are not reinvested, an investor will suffer cash drag. If borrower payments are reinvested, the investment time frame extends considerably.

Reality

The two biggest marketplaces accessible to retail investors in the US, Lending Club and Prosper, both offer a secondary market where it’s possible to buy and sell ongoing loans. For investments made through Lending Club, LendingRobot can automate the liquidation process. LendingRobot has already helped many clients liquidate large portfolios in just a few weeks with minimal or no loss.

4) Investing \$500 is safer than investing \$5,000

Belief

It is better to try investing in peer lending with just a small investment to see how it goes.

Reality

While investing a smaller amount does mean that less total principal is at risk, a small portfolio misses out on one of the main benefits of peer lending: “safety in numbers.” Put another way, the more diversified a portfolio, the more predictable the returns. The data show that investors who have diversified their investment into 200 unique loans have, historically speaking, never lost money. Since the minimum investment is \$25 per loan, investing in 200 loans means a starting investment of \$5,000.

Incidentally, this is the amount of principal that LendingRobot manages for free.

5) Investing is complicated

Belief

It takes a while to study and understand an investment. Peer lending is esoteric and quite different than stocks or bonds; ideal only for the quantitatively inclined.

Reality

Choosing which loans to invest in and which ones to avoid is complex. Most marketplaces offer basic, automated services that allow an investor to obtain, more or less, the average marketplace performance (which is still excellent, by the way). Robot-Advisors like LendingRobot aim to further automate and increase a portfolio’s performance in an easy-to-use way.