Even though I am very passionate about peer to peer lending I never recommend people invest all their money with Prosper or Lending Club. Peer to peer lending should be part of an overall investment strategy that covers a range of asset classes.
What is an Asset Class?
Before I go any further we need to have a basic understanding of asset classes. An asset class is like an investment category – for example the equities that make up the stock market are an asset class. Bonds are another asset class. Cash and cash equivalents (CD’s, money market funds, savings accounts, etc) are another. You could consider real estate another as well as commodities such as gold and oil.
Where Does Peer to Peer Lending Fit?
Peer to peer lending doesn’t fit easily into any asset class – it would be what many investment advisors call an “alternative investment”. It is thrown in with more exotic investments such as futures, currencies, private equity and venture capital. Many of these investments are very high risk, often require a large minimum investment and are subject to wild fluctuations in value. These are not true of peer to peer lending but this is where most people lump it.
Anyway, let’s get back to the original question here. Now, keep in mind I am not a qualified investment advisor, rather I am a self-taught investor with some strong opinions on the subject.
I am not going to get into a discussion here about what percentages of stocks versus bonds an investor should hold. I believe most investors should hold both and in what percentages is a judgment call. Every investor should also have an emergency cash fund in a money market or savings account that you can draw upon for unforeseen expenses.
No More Than 10% of Your Total Liquid Investments
I recommend all investors have no more than 10% of their total liquid investments in p2p lending. Also before they invest a penny they should make sure they understand how investing in Lending Club and Prosper works and the risks involved. The biggest risk is a lack of diversification, this is the one thing that can have a big negative impact on an investment.
Personally, I subscribe to this philosophy. Even though I truly believe in the future of p2p lending, with a mortgage and a family to support I don’t want to be more aggressive than this 10% number. If was young and single I might be tempted to invest 20% or possibly even more but a young person has time on their side.
Why Not More?
Peer to peer lending is not without risks. Just read through the prospectus of Lending Club and Prosper and you will see the risks described in great detail. Putting aside the risk of losing your money to defaulting borrowers there are other risks. This is still a young industry and there is always the possibility that it could be legislated out of existence (not likely but possible).
Five years ago no one would have thought Fortune 500 giants like General Motors or Washington Mutual would go bankrupt. But it happened. Now, both Prosper and Lending Club have contingency plans in place to protect investors should that happen to one of them, but the reality is we don’t know if these plans will work perfectly or not. So there is risk.
Having said that I think the rewards far outweigh the risks but not so much that I would want to put my entire nest egg in p2p lending. I will stick with my 10% maximum and recommend it to others as well. But I am willing to concede that it is a personal preference and others may feel differently.
What do you think? Is 10% not enough or too much? I am interested to hear your comments.