4 Keys to Success When Investing in P2P Financing
Peer-to-peer (P2P) financing has been attracting a lot of attention lately, thanks to its ability to connect entrepreneurs with investors using big data and advanced analytics. For small, growing enterprises, P2P financing can be a great substitute to applying for business financing from conventional financial institutions. On the other hand, as an investor, you have an opportunity to earn returns while helping out SMEs.
If you’re reading this, chances are you’ve been thinking about investing in P2P financing. Before you jump into the platform, you need to do your homework first. How do you achieve the most benefits from P2P financing and invest successfully? Read on to find out.
Research First, Invest Soon After
First things first, do your research. As with any investment, you want to do your due diligence before you take the plunge by understanding how P2P financing works. Start by researching as many P2P financing platforms as possible. Look up their websites and read their profiles. Find out how safe it is to invest through their platforms, what happens when SMEs default, and what happens if the platform goes bankrupt. Read their FAQs thoroughly. If a platform doesn’t share many details, that can be a red flag.
Know Your Personal Risk Tolerance
The higher the potential returns, the higher the risk— and vice versa. That applies to P2P financing, too. Thereby, you need to know your personal risk tolerance before you begin investing. Think carefully about how much risk you are prepared to take.
Carefully consider, are you:
(a) an aggressive investor, who will aim for instruments with higher returns no matter how risky they are?;
(b) a moderate investor, who will accept some risk to the principal but adopt a balanced approach?; or
(c) a conservative investor, who ideally has low-risk tolerance?
Depending on your risk tolerance, you ought to select low-risk SMEs or more profitable but riskier financing opportunities on your chosen P2P platform.
Never Say No to Diversification
Diversification simply means distributing your funds across as many SMEs as possible to prevent loss in case of default. Let’s say you invest RM 1,000 in only one loan with an interest rate of 20% p.a in 12 months. If all goes well, congratulations, you‘ll get a total of RM 1,200 after the loan period has ended.
But we’re talking about the worst-case scenario here. What if the one SME you invested in defaults? You may end up making a loss on your P2P investment.
What if you invest in ten SMEs? If one defaults, your investments will still be profitable because nine SMEs continue to provide returns. With diversification, your returns will stay positive and remain close to the expected rate because you don’t need to depend on just one SME. The more diversified you are, the more protected your investment. Even defaults will hardly disturb your rate of return.
You Can and Should Reinvest Your Returns
Besides diversification, you can also maximize your returns with reinvestment. It simply means using your capital gains to fund other SMEs. Without reinvestment, you will only receive the expected rate of return from SME financing. But with reinvestment, your returns will be distributed to other SMEs. If you do this consistently and continuously, you may multiply your total returns over time.
Besides the four tips above, keep in mind that investing in P2P financing also requires consistency. When you diversify and reinvest, do it regularly and continuously.