How much do investors need to diversify?
Diversification is the first rule of investing. This is true regardless of the size of your portfolio, or your chosen investment sector. All investments come with risk, but there is no greater risk than putting all your money in one place.
Instead, savvy investors spread their money across a range of different sectors in order to minimise the damage from an unexpected portfolio upset.
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Most investors are advised to maintain a mix of equities (stocks and shares), bonds, alternative investments, and cash. The ratio of this portfolio split will depend on the individual investor and their risk profile. For instance, a very conservative investor may choose to keep 60 per cent of their portfolio in bonds and cash, where returns are typically lower but much more consistent. A high-risk investor may prefer to invest in a portfolio of growth stocks, where the returns can be enormous but the risk of capital loss is equally high.
Where does P2P lending fit in?
Peer-to-peer lending is considered to be part of the alternative investment community, which means that P2P loans should represent a relatively small part of any diversified portfolio. In fact, in 2019 the Financial Conduct Authority introduced a new regulation which bans retail investors from putting more than 10 per cent of their investable assets into a P2P lending platform, unless they have had independent financial advice.
Within that 10 per cent P2P allocation, it is still possible to apply the principles of diversification in order to reduce the risk of losses. P2P platforms cover a range of different types of lending options, from business financing to property loans, to consumer loans and even pawnbroking facilities. It is therefore wise to consider diversifying your P2P portfolio across at least a couple of different lending sectors, and it seems that most P2P investors are already doing this.
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A recent survey conducted by Peer2Peer Finance News found that a fifth (19.4 per cent) of P2P lenders are invested in at least six platforms simultaneously, while 48.4 per cent were invested in between two and six platforms.
While the risk of capital loss is generally low in the current P2P landscape, by spreading your money across a range of platforms you are ensuring that should the worst happen and your loan is not repaid, only a small part of your P2P portfolio will be affected.
Most P2P lending platforms allow for even further diversification, by allowing investors to fund multiple loans with a single deposit. Auto-lending accounts bundle different loans according to risk, so that when the investor is ready to make a deposit, their money is spread across dozens or perhaps hundreds of different projects within their chosen risk spectrum.
Many platforms also offer manual lending options where investors can hand-pick the individual loans that they want to support. This allows the investor to take even more control over their portfolio and to diversify on their own terms.
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When done correctly, P2P lending can represent one of the easiest ways to add diversity to a traditional investment portfolio. P2P lending is not correlated with the stock market, so the returns tend to be much less volatile during times of economic turmoil. Even within the P2P asset class, there are many ways to further diversify, by spreading money across different loan types and individual loans. Just stick to the basic principles of investing, manage your risk and check in with your portfolio regularly to maximise your results.