What Is Diversification and Why Is It Important?

What Is Diversification and Why Is It Important?

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Peer-to-peer investments inherently carry some risks. Any portfolio no matter how well set up has those same risks, but not always to the same degree. The difference? Diversification. For investors that want to keep their return expectations high while minimizing risks, diversifying their options is one of the best ways to take advantage of P2P investments.

It’s the same principle that applies for stock purchases—rather than selecting one specific stock to invest in, it’s far more lucrative to select a portfolio that covers multiple different types, each with varying return expectations, risk factors, and trading histories.

As far as P2P investments are concerned, the same thing applies. Lenders that want to invest their money through peer-to-peer lending need to first decide how much they want to invest, and then also where.


Assessing Risks

There are various platforms for P2P investment matching out there, and each has its own unique selling points. Potential investors need to consider factors such as the security of assets, anti-fraud policies, and the financial history of the platform itself when choosing.

Naturally, another concern is the borrowers that the investment will be made available to. Between property, consumer, and business lending, selecting the right market is also a key decision. Every possible segment of the overall borrower pool is subject to certain risk factors—the real estate market and its stability can significantly impact the returns from property lending, for example, whereas consumer lending can be affected by large increases in unemployment.

Once again, the key is variety. A smart lender should try to spread their investment out—across platforms and across borrower types. It’s important to know that there are no “right” decisions when it comes to lending.


Investing in the Many, Not the Few

There are only risk factors and predictions. Since invested capital is always at risk, it’s in the lender’s best interest to spread their money as far as they can. Down to the smallest element, this also means that ideally, money should go to multiple smaller borrowers rather than one large one.

Lending a small amount to ten people is safer than lending a large amount to one—more borrowers mean that even if some default and are unable to make repayments, others will continue to pay, and the returns only decrease, they don’t stop entirely. It’s also less of a financial burden (and therefore easier) to pay back smaller amounts, meaning that in many cases, smaller amounts are more likely to be paid back on time than larger ones would be.

It’s worth noting that a good diversification plan covers as many different sectors and industries as possible—just spreading across different property investments isn’t as secure as investing in properties, people, and businesses. Similarly, investing with several different tech startups, for example, isn’t as effective as investing with different types of companies in different industries.


What about the Benefits?

In addition to strongly mitigating risks to the P2P investments themselves, diversifying has another advantage: it allows the investor to take a more passive approach to the process. While it is possible to build a specific portfolio by hand-picking individual opportunities, this is a huge amount of work and, depending on the scale of the investment, can be nearly impossible to maintain over time.

For portfolio monitoring and reporting, this creates additional burdens as well. Individual P2P loans would require individual return reports, whereas investments through platforms that diversify and spread to different borrowers can more easily be summarized into a single report. For casual investors, this can mean hassle-free money returns without much need for active portfolio management.


P2P and Long-Term Planning

For hesitant lenders, P2P investments can seem risky. At a glance, this is understandable. Most people are used to using banks for all things money; that is, saving, investing, borrowing, and lending. P2P offers a more fluid alternative though that has some very real benefits for investors.

Transparency is one of these benefits. Investors can see information about borrowers and make informed decisions about their money. They can select what they consider the most low-risk opportunities. At the same time, since many platforms offer guarantees, even if a loan defaults, the investor will at least get back their initial investment; in other words, high liquidity and low-risk money planning.

This makes P2P lending a surprisingly attractive option for retirement planning. Compared to traditional savings accounts with banks, this type of investment is likely to generate higher returns, and, unlike pension funds, investors can relatively easily access it whenever they need to. This means that compared to the long-term deposit options that banks offer, P2P lending can show positive results quicker, and the lender has more control over exactly what happens with their money.

Whether it’s for long-term returns, retirement funds, or purely to dip your toes into investing, peer-to-peer lending can be a great tool in any investor’s belt. A smart investor will also diversify their portfolio, for maximum returns and minimal risk—that’s where this type of investment really shines.


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