If you are serious about crowdfunding and want to invest a meaningful amount of money into p2p loans, you will need to pick up basic portfolio management skills. This will help reduce risk and maximize investment return.
Warning: This post is for intermediate investors who already have some experience in p2p lending. If you are new to p2p lending, we suggest you read our Beginner’s Guide to P2P lending.
Time to go passive
If you are investing just $5,000 into p2p loans, you can spend some time to choose the best loan opportunities. However, if you dealing with $50,000 or more, the sheer number of p2p loans in your portfolio will make effective management difficult. It is time to seriously consider passive investing.
In an earlier post, we explained the difference between active and passive investing. Active investing means you are making all the investment decisions. Passive investing means that you are delegating the investment decisions through the use of automated investing tools.
Although passive investing is a sound approach for portfolio management, you should always carefully consider the default rate of any crowdfunding platforms. There is no point in using automated investing if the crowdfunding platform has an inherently high default rate.
Diversification is a powerful risk management technique. But it can be difficult to achieve if your total portfolio size is small (e.g. $5,000). On the other hand, if you have a $50,000 portfolio, you should embrace diversification as much as possible.
In some ways, this is similar to passive investing. Instead of concentrating your investments into a few loans, diversification spreads out your risk so that a single default will not impact the portfolio too much. At the same, the investment return will depend less on your skill, but more the crowdfunding platform’s ability to curate and properly price its loans.
Determine the optimal portfolio size
One important but commonly overlooked consideration is the minimum amount of investment allowable for each loan. This figure determines how effective you can diversify and re-invest your capital. It is possible to determine the optimal portfolio size based on the minimum investment per loan.
If the minimum investment per loan is $1,000 and you want a diversified portfolio of 50 loans, your overall portfolio size would ideally be $50,000 (50 x $1,000).
Assuming 12-month equal repayments for all loans, you should receive $4000+ per month. This amount can then be re-invested to maximise your overall portfolio return.
But if the minimum investment is $5,000 and the portfolio size remains at $50,000, the diversification and re-investment effects will be greatly reduced. A single loan default would mean a 10% damage to the portfolio and you would only be able to re-invest your repayment once every two month.
To achieve the same diversification and re-investment effects as before, you will need to have a portfolio size of $250,000 (50 x $50,000).
Plan before you execute
Good portfolio management starts with careful planning. Do spend some time to think about active/passive investing, diversification and the optimal portfolio size as you scale up your investments.
For an example, please refer to our previous post where we described how we build up our Indonesia p2p portfolio step-by-step.