By Peter Renton
Investors still don’t know where to put their money. Even with the run-up in the stock market over the last few months we are still well below the market highs reached 12 years ago. Bonds have been less volatile and have done quite well in recent years but forecasts for future returns there remains grim.
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Where can investors get a decent return on their money? I believe peer to peer (p2p) lending offers investors the best chance at long term returns in the 8-10% range. So why aren’t investors beating down the door to Lending Club and Prosper.com and investing billions in p2p lending? There are a few reasons that I will detail in this article.
1. People Equate New With Risky
When it comes to investing most people are inherently conservative. This is actually a good thing because there are many dubious investments out there. When something new like p2p lending comes along most people choose to ignore it. There is a “let’s wait and see what happens” kind of attitude. Peer to peer lending is still relatively new, beginning in 2006, so there is not a long track record of successful returns for investors. Without a long track record many investors perceive peer to peer lending risks to be too great, at least for now.
2. Lending Club and Prosper Are Not Profitable
Lending Club and Prosper are still losing money. Their finances are publicly available since the SEC regulates them in a similar way to a public company even though both companies are actually private. Anyone can look at these filings to see the financial health of both companies. With any company that is losing money there is always the concern about bankruptcy and I know investors who have these very concerns about Lending Club and Prosper. In the case of a bankruptcy there are contingency plans in place but there is no legal precedent for such an occurrence. While it is likely that investor notes would not be impacted much by a bankruptcy there are no guarantees.
3. Investors Have a 20th Century Mindset
The general consensus in the last couple of decades of the 20th century is that a mix of stocks and bonds is the best way to invest your money. Despite the mediocre returns this mix has produced over the last decade (not to mention the huge losses in 2008-09) many investors still have this mindset. Investing in these traditional markets is still very popular and many investors remain convinced that a mix of stocks and bonds is the best way to grow your money long term.
4. Investing in Complete Strangers Online Has to be Risky
You would never lend money to a complete stranger and expect to be paid back. Some people think this is what you are doing with p2p lending. When I first explain this concept to people they always think peer to peer lending sounds risky. While it is true you are lending money to complete strangers you do know a great deal about their finances, just not their identity. The borrowers who make it on to a p2p lending platform (the vast majority are rejected) have gone through a rigorous underwriting process and are all considered prime borrowers.
5. Few Financial Advisors Are Recommending It
If you talk to the average financial advisor they will most likely say that peer to peer lending risks are too great for them to recommend. In fact, they probably know next to nothing about it. So when an investor reads an article about p2p lending and they go to their Fidelity or Edward Jones advisor they will not get an informed response. That is slowly changing with at least some financial advisors embracing p2p lending. Both Lending Club and Prosper are working with the investment advisor community to change this lack of understanding.
6. Financial Media Do Not Cover P2P Lending
You regularly see articles in the financial media decrying the low interest rates and lack of returns for fixed income investors. But you rarely see p2p lending featured as a solution for investors seeking yield. There are only occasional articles in major publications like the Wall Street Journal or Forbes magazine. This is slowly changing but today the average investor can easily miss any mention of p2p lending in the mainstream media.
7. The Returns Must be Too Good to be True
In today’s low interest environment returns of 5% or more are viewed with suspicion. Certainly any company that is claiming returns close to 10% should be avoided. You just cannot earn those returns today without taking on substantial risk. Or at least that is the conventional wisdom.
Despite all these headwinds p2p lending continues to thrive. The industry is growing at well over 100% a year while providing returns approaching 10% for many investors. The industry has survived the financial crisis, regulatory changes and some early missteps to emerge as one of the few places investors can earn a decent fixed income return today. Some institutional investors are taking notice and putting large sums of money into Lending Club and Prosper.
On a personal note, I believe that p2p lending is the best risk/reward investment available today. Peer to Peer Loans are not without risk but investors are very well compensated for taking that risk. I believe it is going to be a trillion dollar industry one day and will become an integral part of the financial system in the future.
Peter Renton is the publisher of the Social Lending Network, a blog focused on the peer-to-peer lending industry.
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