Wealth Creation through Peer-to-peer (P2P) Lending
Welcome to 2018! As we enter the New Year, it’s time to be reinvigorated about saving, investing and reinvesting. The importance of these 3 components cannot be overemphasised as they are essentially interdependent building blocks of wealth. A failure to address either component could potentially derail your progress of wealth creation.
So, how do we efficiently create wealth?
Wealth creation starts with saving.
If you fail to save enough of your monthly earnings, that failure will adversely affect other components of wealth creation such as investing and reinvesting. Without ample savings, you will lack the money to invest. And with very little being invested, the returns or yield from an investment may not be meaningful, when reinvested. Therefore, wealth creation will be unnecessarily hampered.
The general idea of saving is to pay yourself first before anything else. That means setting aside between 5% and 20% your monthly earnings (excluding EPF) for wealth creation purposes. I’ve linked some interesting articles about saving. See: Reference below.
Even though I may not be regimental about saving, I think setting aside a minimum of 20% of monthly earnings (excluding EPF) is prudent and manageable for almost everyone. This practice must be executed consistently throughout your lifetime, so much so that it becomes a virtuous habit.
Money saved can be subsequently used to acquire certain assets with the potential to generate wealth. This is a fundamental point of investing.
These assets should fulfill a criterion: increasing in monetary value over time, or generating income periodically, or both. In other words, assets which increase your popularity among friends, while making you poorer, should be avoided.
Acquired assets must be compatible with a purpose. That purpose may be retirement, education, a holiday and etc. Further, acquired assets, must also be in line with your financial circumstances (your age, earnings, liabilities and etc) and also suit your investment risk profile.
In selecting an asset for wealth creation, I typically choose the ones which could potentially generate a higher return without much risks of losing money.
The last component of wealth creation is reinvesting the returns from your investment. By reinvesting the returns, rather than paying out the returns, you are using the power of compounding returns to your advantage. Compounding returns is achieved by generating return on return. Hence, the value of your investment will magnify over a period of time.
Albert Einstein was clearly fascinated by compounding returns:
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
Warren Buffett’s paid homage to compound returns for his phenomenal wealth:
“My wealth has come from a combination of living in America, some lucky genes, and compound interest.”
Therefore, it is rather obvious that your choice of asset classes must possess an inherent quality that enables returns to be compounded.
While the returns of most assets classes can be compounded, focus must be had to the frequency of compounding. This is achieved by increasing the rate of compounding. For instance, if all things being equal, a return, generated on a monthly basis, can be compounded at a higher rate than a return generated, and compounded, on an annual basis. Imagine the following scenario:
Investment A pays an interest of 10% per annum.
Investment B also pays an interest of 10% per annum but is compounded on a monthly basis, for 1 year.
At the end of the year, an investment of RM10,000.00 in investment B will generate a return of RM11,047.13. An initial investment of RM10,000.00 in investment A, on the other hand, will yield a lesser, RM11,000.00.
P2P lending, among others, is an asset class which fits into my investing criteria because the returns from P2P lending, through Funding Societies Malaysia, is relatively high i.e north of 10% per annum (excluding service fee).
Every return garnered from P2P lending can be reinvested, to reap the benefits of the power of compounding returns.
A high rate of compounding is achievable because most of the fundraising exercises, approved by Funding Societies Malaysia, repay your capital plus interest, on a monthly basis.
Unlike Investment B above (where only the return is compounded monthly), P2P lending enables the reinvestment of the return of your capital plus interest, on a monthly basis, to achieve a better overall return. Hence, if you reinvested the return of your capital and interest, on a monthly basis, at the rate of 10% per annum, you may effectively garner up to 18% return on your investment, per annum.
Further, the minimum investment amount of RM100.00 facilitates reinvestment too by lowering the barrier to reinvesting.
P2P lending has proven itself as a reliable investment. It has very little volatility and a high fixed rate of return. These qualities add an element of certainty to an investment portfolio and will augur well with a wide range of investors – from young to old, conservative to aggressive.
However, you should always be mindful of a risk of default notwithstanding that such risk is low.
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** This article is written in association with Funding Societies Malaysia. **
Steven last edited by
is P2P better return compare with unit trust?
2387581 last edited by
@steven There are different kind of risks between P2P lending and Unit Trust.
P2P lending - you are a moneylender. Risks are rather concentrated on a few borrowers. When they decided to default, or should their companies wind up or directors take flight, I would assume you lose 100% of your capital. Of course, in FS Malaysia this has yet to happen, so we don't know for sure.
Unit Trust - by nature most unit trust funds invest into equities of public listed companies or bonds issued around the world. PLC has a lot to disclose so there are more transparency, where you may judge whether a company is good or bad, therefore deciding whether the fund which invests in these companies are performing or otherwise. Some fund can have 10% return in a month, some may stay stagnant for prolonged period, while some may make losses. When unit trust NAV (net asset value) drops, if future prospects is good, then there are hopes that it will go back up. And every fund invests in a basket of stocks/bonds, so by nature a UT fund is already a rather diversified instrument.
@Steven It's comparing apples and oranges. Both have their own strengths and disadvantages.
P2P lending is an investment into debt. Another debt investment is bond.
Unit Trust is an umbrella term. Depending on what unit trust, returns may vary. Before you invest in unit trust, you must know what type of unit trust that you are investing. The most common funds are bond funds and equity funds.
I've got a guide written about mutual funds. Hope it shed some light.
Steven last edited by
thanks for sharing blog!