When it comes to investing, diversification is key. A well-diversified portfolio can help mitigate risk and increase potential returns. While traditional investments like stocks and bonds are often the go-to for many investors, alternative investments like peer-to-peer (P2P) lending should also be considered. In this article, we'll explore the importance of P2P lending in portfolio diversification and why it should be a part of your overall investment strategy.
The Importance of Diversification in Investing
Before we dive into the specifics of P2P lending, let's first understand the importance of diversification in investing. Diversification is the practice of spreading your investments across different asset classes, industries, and geographies. This helps reduce the risk of losing all your money in case one investment performs poorly.
For example, if you only invest in one company's stock and that company goes bankrupt, you could potentially lose all your money. However, if you have a diversified portfolio with investments in various companies, industries, and asset classes, the impact of one investment performing poorly is minimized.
What is P2P Lending?
P2P lending is a form of alternative investment where individuals lend money to other individuals or businesses through an online platform. This type of lending cuts out traditional financial institutions like banks and allows individuals to directly lend and borrow from each other.
P2P lending platforms act as intermediaries, connecting lenders with borrowers and facilitating the loan process. These platforms also handle the administrative tasks, such as credit checks, loan servicing, and collections.
The Benefits of P2P Lending in Portfolio Diversification
Higher Returns
One of the main benefits of P2P lending is the potential for higher returns compared to traditional investments. According to a study by the Federal Reserve, the average annual return for P2P lending is around 7%, while the average return for stocks is around 10%.
P2P lending also offers the potential for passive income, as the interest earned from loans is paid out to lenders on a regular basis.
Low Correlation to Traditional Investments
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P2P lending has a low correlation to traditional investments like stocks and bonds. This means that the performance of P2P lending is not directly affected by the performance of traditional investments. This makes it a valuable addition to a diversified portfolio, as it can help reduce overall risk.
Access to Alternative Investments
P2P lending is considered an alternative investment, meaning it is not a traditional investment like stocks or bonds. Alternative investments can provide diversification and potentially higher returns compared to traditional investments. By including P2P lending in your portfolio, you can access this alternative asset class and potentially increase your overall returns.
Lower Minimum Investment Requirements
Unlike traditional investments, P2P lending has lower minimum investment requirements. This means that individuals with smaller amounts of capital can still participate in this type of investment. This makes P2P lending a more accessible option for those looking to diversify their portfolio.
How to Incorporate P2P Lending into Your Portfolio
Now that we understand the benefits of P2P lending in portfolio diversification, let's explore how to incorporate it into your overall investment strategy.
Determine Your Risk Tolerance
Before making any investment decisions, it's important to determine your risk tolerance. This is the level of risk you are comfortable with when it comes to your investments. P2P lending is considered a higher risk investment compared to traditional investments, so it's important to assess your risk tolerance before adding it to your portfolio.
Allocate a Portion of Your Portfolio to P2P Lending
As with any investment, it's important to not put all your eggs in one basket. Allocate a portion of your portfolio to P2P lending, along with other traditional and alternative investments. This will help diversify your portfolio and reduce overall risk.
Choose a Reputable P2P Lending Platform
When it comes to P2P lending, it's important to choose a reputable platform. Do your research and look for platforms with a track record of successful loans and satisfied investors. It's also important to consider the platform's fees and interest rates when making your decision.
Monitor Your Investments
As with any investment, it's important to regularly monitor your P2P lending investments. Keep track of your returns and make adjustments to your portfolio as needed. This will help ensure that your investments are performing as expected and that your portfolio remains diversified.
Real-World Examples of P2P Lending in Portfolio Diversification
LendBox
LendBox is one of the largest P2P lending platforms in India. It offers personal loans, business loans, and auto refinancing loans. Investors can choose which loans to invest in based on factors such as credit score, loan term, and loan purpose. LendBox has a minimum investment requirement of Rs.1000 and offers an average return of 8-12%.
Others
A lot of NBFCs also started offering the P2P loans and full P2P services platform that focuses on small business loans. Investors can choose which businesses to lend to based on factors such as industry, loan purpose, and credit score. They has a minimum investment requirement of Rs.10,000 and offers an average return of 7-13%.
Conclusion
P2P lending is a valuable addition to any well-diversified portfolio. With the potential for higher returns, low correlation to traditional investments, and accessibility for smaller investors, it's worth considering as part of your overall investment strategy. By following the tips outlined in this article, you can successfully incorporate P2P lending into your portfolio and potentially increase your overall returns.
At Yield, we partner with the LendBox to facilitate the investments in P2P and one can start with as low as Rs.100 for 10% fixed interest. Check out the asset now.
