All within a span of the last couple of years, the concept of crowdfunding, especially P2P (peer-to-peer) lending, seems to have taken on with most SME owners as an acceptable alternative source of business financing.
Most would attribute the technology’s rapid growth in exposure and widespread acceptance to its ability to connect businesses with a wide range of investors through the use of big data, digital technology, and advanced analytical prowess.
For startups, or small, growing enterprises, P2P lending could very well be a substitute and lifeline to the traditional business bank loan.
Even better, everyone who is signed up on a particular P2P lending platform, gets an equal opportunity to invest and earn returns of 16 – 25% annualized, while helping out SME owners.
If you happen to be reading this, chances are that you are either doing a little research into P2P lending for general knowledge, an essay that you have to write for a project, or you are thinking about investing.
However, just before you hop onto the platform with idealistic dreams of relying on the P2P lending scene to garner you a 25% return on investments for the year, you need to understand a little more about the industry.
It is imperative that you begin to think about how you can achieve the most benefits from P2P lending, and about how to best ensure that you maintain a successful run of investments.
Read on to find out more.
Step 1 — Research Must Precede Investment
As a fundamental rule of thumbs, we should never invest in anything that we do not understand deeply. For the sake of being prudent, it is essential that you carry out due diligence to thoroughly understand how P2P lending works.
To get the ball rolling, you may begin by signing up on as many P2P crowdfunding platforms as possible, to read the content on the websites, and to understand the benefits that each platform has to offer. Go online to search for in-depth information on the various platforms, and look out for reviews made by individuals who have had experience with P2P lending.
Grasp the potential upside, along with its possible pitfalls, then decide if it is safe to invest. Understand the process of investing through the platforms, the possible avenues of recourse in the event of non-performing loans, and what happens if the platform dissolves.
Be sure to read through the terms and policies. If you feel that a particular platform is not being open about certain details or questions that you have posed, it can be a warning sign for you to be cautious.
Step 2 — Always Manage Your Risk
So the old saying goes, that there is no free lunch in this world. The higher the potential returns, the higher the risk. One cannot eat a cake and keep it at the same time.
Such wisdom also applies to P2P lending, hence the need for us to be prudent. We understand ourselves best. You need to be aware of your risk threshold before throwing money into any investment.
Think about your risk appetite, are you:
(a) An aggressive investor, who only eyes the reward, and charges in despite the amount of risk taken.
(b) A moderate investor, who draws a fine balance between risk and reward, often opting for the dive as long as circumstances seem fine in general.
(c) A conservative investor, who will only invest in sure win, or very low risk situations, even if earnings are significantly less.
Therefore, it is of great importance for one to understand about what they are looking to invest in, as well as themselves and their thresholds to risk exposure.
Step 3 — Diversify
In the realm of P2P lending, the concept of diversification is simple and straightforward. It refers to the allocation of funds across as wide a span of loans as possible. It is basically a volume game; the more loans your funds are spread across, the more likely you are to profit overall, assuming that only a small percentage of loans end up defaulting.
Now, supposing that you are invested in a single loan, and this one loan defaults? Probability is that you will make a total loss, with no returns from other successfully repaid loans to lighten the loss.
However, imagine being invested in 10 different loans? Even if 1 or 2 loans failed to perform, there will still be a decent chance that your portfolio will turn a profit, because of the returns from the other 8 or 9 loans.
Diversifying prudently will ensure that you gain a profit, or at least, allow you to hedge against the risk of losses.
Step 4 — Compound Your Profits
Other than just spreading one’s eggs over many baskets, one should also consider reinvesting and compounding interest returns. Through the powerful effects of compounding, an investor puts himself onto the track of ่exponential earnings, on top of interest returns on a loan.
When reinvesting, your returns are essentially re-distributed to other SMEs as funding. If you do this consistently ่and continuously, your total returns will grow exponentially over time. Such is the power of delayed gratification, which we shall leave as a topic for another article.