What is Passive Income?
There have been articles before on the VIAINVEST blog post about creating a passive income online. Developing passive income streams to provide ongoing income is a very positive step to improving your financial health. Previous articles have looked at passive income more generally, whereas this focuses purely on Peer to Peer Lending as an income source.
Why is P2P Lending a Good Source of Passive Income?
Over the long term, the effects of compounding interest (where both interest and capital is reinvested) are dramatic. Einstein apparently called it the eighth wonder of the world! With stock market investments, you often have to pay a trade fee to reinvest the dividends. This can eat into the ongoing returns. However, with P2P lending there are usually no transaction fees to purchase new loans.
Less Volatile Income
Investing in peer to peer loans has been far less volatile than investing in the stock market over the last few years. Traditionally income investors would have to trade off the pro’s and con’s of equities (higher return, higher volatility) against bonds (lower return, lower volatility). With a diversified portfolio of P2P loans, you have the potential to achieve the best of both worlds.
Can Sell Out If Necessary
If you need access to your capital, you can often sell out of peer to peer lending investments quite quickly. Platforms usually have a secondary market or offer short loan terms, to leave investors with a reasonable degree of liquidity.
It Helps Borrowers Too
Peer to Peer lending is not only good for investors. It also helps borrowers by reducing the rates of interest they pay relative to traditional banking loans. So, not only does your investment create an ongoing income stream for you, but it helps others too.
What factors to Consider When Choosing a P2P Platform for a Passive Income Stream?
Truly Automated Lending
A lot of people get started with peer to peer lending has been unhappy with the rates of return they were getting from bank savings. The initial enthusiasm of P2P lending and the rates on offer means that often people are happy to put a bit more manual effort into managing the investment. However, if they are not careful, they can end up spending several hours a week managing their investments or choosing individual loans. Depending on the investment amount, it can become almost like a full-time job. If you want to develop a truly passive income, it’s important to check what sort of auto-investment functionality platforms have. Will you trust the robot with your investment capital?
The P2P Lending ecosystem is highly diverse and you can find all sorts of loan arrangements. Some platforms offer a ‘bullet loan’ where interest is accrued on loan and only due at the end of the term. In real life, often unexpected things happen: loans run overdue, refinancing arrangements fall through, and repayment needs to be extended or even defaulted. If you are relying on your investments for regular income, these types of bullet loans may be less desirable as repayment is less predictable.
On the other hand, you have platforms which offer shorter term loans with regular repayments. These can potentially provide a less volatile monthly return, ideal for passive income.
High Rate of Return
This may seem obvious, but it’s important to look for a high rate of the return. To create a basic scenario: imagine you want to build a passive income of €800 per month and have two possible investments. The first provides an ongoing income of 5%, and the second provides a continuous income of 12%. You’d need to invest €192,000 into the first investment to meet your passive income goals. You’d only need to invest €80,000 into the higher paying investment to generate the same ongoing income (this was calculated via €800 x 12 months/rate of return).
Although a high rate of return is important, it’s important to not chase high yields at the expense of taking on too much risk. Warren Buffet, perhaps the world’s most respected investor, has two great rules for investing. The first is ‘never lose money.’ The second rule is ‘repeat number 1’.
So, when choosing a P2P lending platform to invest in for a long-term passive income, it’s important to research the risks of the investments listed and the company behind the financial platform itself. Once you start investing, most investment professionals would agree that diversification is the best way to reduce risk while maintaining a high rate of return. For this reason, a platform that allows easy diversification across a wide range of different investments is something to look for.