4th Way highlights 11 key P2P lending risks
Peer-to-peer lending review site 4th Way has highlighted what it sees as the 11 key peer-to-peer lending risks.
Top of the list, the site flags “psychological risk”, arguing that issues are often down to the investor’s own behaviour, attitude and temperament.
According to 4th Way’s detailed blog post, greed, blindly following market hype, over-confidence in your own knowledge and fear are all among the psychological risks that investors face in P2P.
The blog points out that between 2005 and now, the P2P lending industry has been shown to be stable and resilient for individual lenders, surviving the financial crisis of 2008 and the pandemic. However, 4th Way is keen to urge investors that, as with any investment, there still are some inevitable risks.
To avoid this risk, 4th way advise that investors have a set of criteria they stick to when choosing investments and conduct their research from a sceptical perspective.
Read more: 4th Way names top six P2P platforms of 2022
The second risk highlighted is lack of diversification. “Spreading your money across dozens of prime property loans, or hundreds of small personal or business loans, reduces the risk of suffering severe losses from bad debts to a minuscule fraction of the risk compared to lending to just one borrower”, the blog says.
This includes spreading risk across different P2P lenders, and holding onto loans until they’re repaid, so you make all the interest possible on good loans and leave time for bad debts to be recovered.
Third, is credit risk. Which basically mean lending to the right borrowers. “Of all the peer-to-peer lending risks that we face, this is the one which 4thWay spends the most time assessing”, the blog says. To mitigate this risk, the advice is to choose high-quality P2P lending accounts.
This ties into the fourth point, platform risk. This is where one of your P2P lending sites collapses, and it becomes difficult to get your money back. In the UK, the Financial Conduct Authority requires regulated platform to have fully funded wind-down plans, offering some protection.
Read more: 4th Way improves Invest & Fund’s risk rating due to ‘perfect record’
The risk of fraud or negligence is also present on P2P sites, and 4th Way says this one should be one of the easier to avoid. Don’t invest with an unregulated platform and look out for poorly produced and written websites or limited information and aggressive marketing language.
Next is liquidity risk, or your money being tied up, which 4th way says is “part-and-parcel of this form of investment” from time to time. “When you can’t sell, your loans still accrue interest and the borrowers repay eventually, so it’s not the end of the world”, it says.
Next is “cash drag” where your money is held in your lending account but not yet earning interest by being lent out. 4th Way says this is usually easily resolved by moving the money elsewhere if the platform has too few loans for you to lend. However, while the money is waiting for a suitable loan, it is not at risk, it is just not earning interest.
Finally, the site flags inflation, regulatory changes and currency risk. 4th way advises lenders to “make sure you’re lending in some lending accounts where the loans are shorter, so that you’re quickly able to redeploy your money in newer loans that have higher rates to compensate for inflation risk”.
To avoid currency risks, lend in your own currency as much as possible, or lend across many currencies to hedge the risks, 4th Way says.
Read more: The risk hunter: 4th Way’s Neil Faulkner
