P2P versus bonds: How should investors choose?
There are many similarities between peer-to-peer loans and bonds. They are both debt-focused investments. Both offer a fixed return over a set period of time, with the capital repaid at the end of the term.
And both of these investments can be eligible for tax-free wrappers such as the Innovative Finance ISA (IFISA). Furthermore, neither of these investments are protected by the financial services compensation scheme (FSCS) and therefore come with a risk of capital loss.
However, this is where the similarities end. P2P lending is its own financial entity, regulated by the Financial Conduct Authority (FCA). It brings together lenders and borrowers on a third-party platform where lenders can choose to fund a variety of projects in exchange for a pre-agreed return.
Read more: P2P lending retains its edge as base rate rises
The bond market is a little more complicated. It runs the gamut from corporate bonds to government-issued bonds (or ‘gilts’) and even P2P-like crowd bonds.
Whereas P2P lending has only existed for less than 20 years, the first ever bond was issued way back in 1693. Its longevity naturally means that the bond market has matured exponentially.
By 2021, according to the Securities Industry and Financial Markets Association, the global bond market was estimated to be worth $119trn (£95.19trn). By contrast, the current value of the global P2P market can be counted in billions.
This means that there is far more choice for bond investors, who can choose from a range of different risk options. Gilts tend to represent the lowest-risk bond option, as these bonds are issued and underwritten by national governments. The more financially stable the country, the lower the risk of the government defaulting on the repayment. This equates to lower returns.
Read more: What is an IFISA?
Corporate bonds are considered to be higher risk, as they do not have the heft of a national government behind them. Ratings agencies such as S&P can help offer some indication as to the risk profile of the corporation behind a particular bond offering. If a company has an A+ debt rating, it is extremely likely that your money will be returned to you at the end of the term. If a company has a D rating, this indicates a higher risk of default.
As with anything in finance, the higher the risk, the higher the return. It is particularly important to bear this in mind when dealing with the bond market, as it often requires a high minimum investment threshold and a long term. Once your money has been invested in a bond, you could be penalised for removing it early.
In this sense, P2P loans offer something that bonds do not – liquidity. Most P2P lending platforms offer a secondary market where loans and loan parts can be traded at a premium or discount, depending on the market. This means that it is possible to exit a P2P investment early without incurring a financial penalty.
Read more: Are P2P investments FSCS protected?
Furthermore, all P2P loans can be held within an IFISA wrapper, which ensures that any interest earned on your investment will never be eligible for taxation. Confusingly, IFISA wrappers are also used on crowd bonds – a type of corporate bond which operates in a similar way to P2P lending, by inviting a group of investors to back one project.
Whether you choose to invest in a low-risk gilt, a higher-risk corporate bond, an IFISA-wrapped crowd bond or a P2P loan, the same rules of investing will always apply. Do your due diligence until you are confident that you understand the risk that you are incurring, and the likelihood of default. Never invest more than you can afford to lose. And always maintain a diversified investment portfolio which includes both debt and equity plays.