By Thomas M. Kostigen
“Neither a borrower nor a lender be” is age-old conventional wisdom. But in today’s financial market environment, it may be wise to be both.
With interest rates at record lows and the stock market turning in record returns, borrowing money and investing that capital to gain the difference might be a tempting strategy. After all, borrowing rates are in the low single digits while many fund managers are getting double digit returns year-to-date. Of course, this strategy is risky. Since the money isn’t yours —it’s debt that will have to repaid—there is the chance the stock market will fall and you’ll be out those losses, plus the principal and interest owed.
Peer-to-peer lenders, or crowd funders, on the other hand, can take a lot of the risk out of this type of strategy. Moreover, you can play just one side of the trade and invest in other people’s borrowings. Here’s how that works: a person applies for, say, a personal loan through a peer-to-peer lending organization. He or she applies just like they would with a bank, providing credit and employment information. A loan is generated and the credit amount is assigned an interest rate. The interest rate is typically higher than what a bank would charge. Meanwhile, investors can invest in that person’s loan (along with others to lessen the risk). Once enough investors’ capital is received, the loan is funded. The borrower gets his or her money, and investors get returns on their capital. And the lending organization gets its fee for matching investors with borrowers.
Peer-to-peer lending organizations are very popular with millennials who, according to numerous studies, don’t trust banks and traditional institutions According to moneyunder30.com, “Peer-to-peer lending continues to grow in popularity and is becoming a much more viable option for people who need money and for people who want to invest their money.” It cites a number of P2P lenders that are doing right by borrowers and investors alike: “While Prosper is the oldest of the bunch, don’t lose sight of newcomers like Upstart that offer a different spin on things. Kiva will help you do your part in helping businesses across the world, while companies like StreetShares will allow you to profit from it.”
To be sure, P2P lending (and investing) has its critics. Personal finance guru Dave Ramsey claims it is a “fad thing” and that the people who utilize such credit options can’t get a loan at a bank. Therefore, he says it’s an ultra-high risk investment for investors. That isn’t always the case, as different borrowers have different credit ratings—and some just don’t like to or want to deal with banks. Still, seeking guidance from a professional investment counselor such as a financial adviser may be beneficial to gauge the risk of P2P investing and whether it’s right for you.
Whether borrower or investor, forecasts are for massive growth in the sector. The global P2P lending market size was estimated at $67.93 billion in 2019 and is expected to reach $558.91 billion by 2027, rising at a compounded annual growth rate of 29.7 percent between 2020 and 2027, one study says.
Digitalization is they key driver of the market, as technologies can produce efficiencies with which banks — saddled by legacy costs and regulations—just can’t compete. Also, new technologies bring transparency options so investors can better vet transactions.
The bottom line is that P2P is a new type of investment class that might be appropriate for portfolio diversification or other financial planning upshots. P2P then is worth learning about if not investing in. People who are stuck on age-old wisdom may disagree. But these are new times in which we are living. Investments should reflect that.
Thomas Kostigen is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Thomas is a best-selling author and longtime journalist who writes about environmental, social, and governance issues.
