What is your game plan for p2p lending? Do you intend to pick p2p loans yourself? Or would you rely on the crowdfunding platform to do the loan selection for you? The former is known as active investing; the latter passive investing. Both have their pros and cons, but smart investors that understand both strategies would be able to use both to their greatest advantage.
Active investing is a strategy where the investment manager makes specific investment decisions in order to achieve his or her investment objectives. This approach is actually very common in the fund management industry. Most active managers have mandates to deliver market-beating performance.
In p2p lending, active investing would simply mean that the investor makes all the investment decisions – whether or not to invest in a p2p loan opportunity, how much to invest, etc. Active investing actually involves several skillsets, such as credit analysis, risk management and portfolio management.
Passive investing is a strategy where the investment decisions are based on rules and require minimal involvement from the investment manager. ETFs and index funds are good examples of passive investing in the fund management industry.
Several crowdfunding platforms (such as MoolahSense, Capital Match and Crowdo) support passive investing through automated investing. This feature allows investors to specify their investment criteria and funding amount in advance. When a lending opportunity comes up that meets the pre-defined criteria, the platform automatically selects and bids for the loan.
Capital Match’s Automated Investing Feature
Crowdo’s Automated Repayment Rollover
Active or Passive. Which is better?
Both active and passive strategies have their pros and cons.
Active strategy is a great way for investors to learn p2p about lending. It requires some time and effort but investors have full control over loan selection. It is suitable for investors who wants full control over the selection of lending opportunities.
Passive strategy is useful for investors who are already familiar with the basics of p2p lending and do not have the time to analyse each lending opportunity. It makes p2p lending easier, but the risk is that the investor is now completely dependent on the crowdfunding platform to properly vet the loans.
Our Experience: Active-Passive Strategy
It is also possible to use a combination of active and passive strategies. In fact, this is how we (the Let’s Crowd Smarter Team) manage our real money p2p portfolio.
For any new crowdfunding platform, we always start with an active investing strategy – analysing and selecting every loan opportunity. After about a year, we’ll do a quick review. If our investment performance is satisfactory and we’re comfortable with the credit underwriting at the crowdfunding platform, we’ll switch to a passive strategy. For platforms where we find fewer lending opportunities, we tend to continue using an active investing strategy.
The advantage of our approach is that it delegates investing decisions to platforms that we are familiar and comfortable with. This frees up time for us so that we can take a more active approach with other less familiar platforms.
Don’t rush into automated investing
Automated investing is a great tool and is essential for serious investors who want to build up a sizeable p2p portfolio (e.g. more than $20k). But it can be dangerous for beginner investors.
This is because automated investing alone is unlikely to produce good returns if the platform’s underlying loan performance is poor. Investors should always find out about the track record of any platform first. Also, some platforms may require high minimum amounts for the automated investing. For example, a $25k commitment that automatically invests into $5k into 5 loans would mean a 20% exposure to each loan. If just one loan goes bad, the entire portfolio will likely be loss making.
In our view, beginner investors should always start with an active investing strategy first and consider moving to a passive investing strategy only when they are thoroughly familiar with the basics.