I often ponder peer to peer lending risk, especially when considering how much of my overall net worth to invest. How risky is peer to peer lending? It’s the question I’m emailed the most by readers of this website.
That’s why I created the risk meter. My company risk ratings are a culmination of several factors rolled into an easy to understand number. This number is designed to give you a general overview of how risky I consider a peer to peer company and its products to be.
(Note that I rate risk within the peer to peer lending / alternative finance sectors only. For example, I might rate Acme P2P Company a level 3 risk when compared to other peer to peer companies, whereas if I were comparing Acme P2P Company to other investments outside of peer to peer (ex. shares or rental property), it might be considered a level 6 risk).
The factors I consider when assessing a risk rating are loan and product types I use*, interest returns, company history and age, company accounts (if known), default experiences and stats, provision fund, and my own investing experience. Certain companies allow me to openly communicate with the directors and I factor this into my risk rating. Sometimes warm and fuzzy feelings come from these conversations as they provide me insights into company futures and the experience of the staff.
You will see various websites offering their own risk ratings on peer to peer companies. Their risk rating, like mine, is nothing more than an opinion. In many cases, it’s impossible to know what’s going on behind closed doors of a financial company. Even successful publicly owned companies have gone bankrupt due to mismanagement or economic downturns so no business is immune to failure.
While risk can be estimated to some degree, there are too many unknown variables that can change risk at any time. Please use my risk rating as a part consideration of a whole decision, rather than as a recommendation.
Risk comes in three layers. Peer to peer lending as a whole versus other forms of investing, how risky the peer to peer companies are and how risky each individual peer to peer investment product and loans is.
No matter how risky you deem a company or product to be, try not to allocate too much money into any single type of investment or company, just in case disaster strikes. Larger, more profitable companies than the ones listed on this website have gone out of business. No company is immune to failure. I personally spread of entire investment net worth over index trackers, peer to peer lending, property and cash. I do not purchase individual stocks and shares as I view the risk to be extremely high. You can read articles about this here.
Risk Ratings Explained Further
I categorise risks from 1 to 10, one being the least risky and ten being the riskiest. Below is an explanation for levels one and ten as the other levels are mainly self-explanatory and fall somewhere in between.
Risk Level 1
Risk level one investments are the ones I consider to offer the least amount of risk within the peer to peer and crowdlending sector. These companies are usually well funded, have a longer operational history, high quality underwriting staff and competent risk assessment teams. Lender interest returns are usually in the lower range. There is still risk involved when you invest at level one and so far no company has achieved less than a 2 risk score.
Risk Level 10
Risk level ten companies usually offer a higher rate of return in the 10-30%+ range. These companies may have a shorter operational history (or are new), have limited company accounts information, offer higher risk loans, be underfunded, have a smaller loan book, have experienced a large number of unrecovered defaults, be based outside of the UK, or are unregulated.
I hope this page gives you a clearer understanding of how I base my risk ratings. Remember that the alternative finance sector is still new and while I’m hopeful for its continued growth and success, all investments and companies carry risk. Zopa is the only peer to peer company I know of to survive the 2008 financial crisis. When the next financial recession occurs, I expect there to be peer to peer lending company casualties, I just don’t know to what degree.
With this in mind, please diversify your investments across several companies and multiple loans and don’t invest more money than you can afford to lose.
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** The information contained on this page is for information purposes only and should not be regarded as investment advice. Opinions expressed are based on my own personal experiences. As with any financial investment, peer to peer lending involves risks, so never invest more than you can afford to lose. **
