Lending money to someone, ensuring regular interest payments, and eventually the return of principal on time — it is a tough job. Sure, P2P platforms make the task a lot easier for lenders. However, first-time lenders on these new digital platforms still find the task arduous. Here are a few common mistakes you can avoid and make money on a P2P lending platform.
Chasing high returns
Interest rates as high as 35 per cent can lure you to invest in P2P lending. But lending with the sole objective of earning very high returns may not be a great approach. Investing only in high risk borrowers may backfire.
“Don’t forget that higher the returns, the higher the risk. Whenever you are investing in a new financial product, it becomes important to start slowly and gauge how you are succeeding in your investment plan. Always start with small investments across different products. After gaining adequate experience you can decide on how to build your portfolio for the long term,” says Bhavin Patel, Founder and CEO, LenDenClub, a P2P platform.
“A prudent approach would be to have balanced funds in a savings account, FDs, MFs along with instruments like P2P loans to ensure adequate safety as well as liquidity.Taking available funds, especially if you have no other savings, and investing on a P2P platform lured by the lucrative returns is a pitfall you should avoid,” says Dhiren Makhija, CEO, Cashkumar.
P2P platforms usually divide the borrowers in risk categories depending on their repaying capacity. A higher interest rate depicts higher risk of repaying while the borrowers with lowest interest rates indicates the least risk of defaults.
Lack of basic understanding
Yes, it is true that you can earn higher returns through lending money on a P2P platform. But do you understand how a P2P platform works; what are the dos and don’ts while lending money on a digital platform. If you haven’t bothered to check these basic factors, you may be in for trouble.
As said before, do not focus solely on higher returns. Also, you should try to learn how various financial instruments, including P2P, work before investing in P2P platforms, say experts.
“If you do not understand the basic aspects of P2P investments, you will not be able to judge where to invest, how much to invest and what you will receive. Proper research about the platform, products on offer and most importantly the numerous risks associated will help you to invest in the right way,” says Patel of LenDenClub.
Don’t focus on short-term returns
“Do not compare P2P with equity investments in the short term. This is a 36-month product. Over a long period the returns can be similar to equity,” says Mukesh Bubna, Founder, Monexo.
This is the most common mistake by investors. Though, the returns can be similar or higher than equity in some cases, it’s essential to understand how the returns are calculated.
Many investors tend to withdraw their monthly returns. Thus, missing out the compounding effect in their portfolio. “Any P2P lender should have a long -term view over a period of three to five years to start withdrawing the money. Then only would he be able to see the great returns on this new investment asset class,” adds Patel of LenDenClub.
Bubna seconds the approach and adds that, “Compounding effect will come only when the interest is reinvested.”
Lack of diversification
Little or no diversification can impact your net returns from the portfolio. It’s advisable to spread the risk by dividing the amount among many borrowers.
Ashish, a lender on Faircent.com, says, “When I first started lending, I had Rs 1 lakh in hand which I divided among 10 borrowers. Over the last two years, I have realized how much sense it makes to diversify. Today, I don’t invest more than Rs 2,000 per borrower. In some cases, I even invest as low as Rs 750 per borrower. I use auto-invest because it makes it convenient to invest in a large number of borrowers and use the reports available on the platform to keep a track of my borrowers and portfolio’s performance.”
Bubna of Monexo also emphasises on the “fractionalisation of loans”. He advises lenders to invest among spectrum of interest rates and not only go for higher interest rates.
Not mentally prepared for delays
Many lenders do not give attention to default rates. They are stunned when there is delay in repayments. It’s imperative for investors to understand sometimes there can be delayed. “Since the returns are on reducing balance and come in EMI form. Investors should be mentally prepared for delays, if any,” says Raghavendra Pratap Singh, Co-Founder, i2ifunding.
As per RBI, each P2P platform is required to disclose their delay and default rates, something which investors tend to overlook. Understanding these default rates will give investors a better idea of each platform’s risk. Investors looking at multiple platforms should try and draw correlations between the platform’s advertised average ROI and their default rates.
Credit: Economic Times