The 3 Rules of Peer to Peer Lending for Investors

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In our previous articles, we explained why lending through BTCJam is such a great idea and how this enables a really great return/risk ratio.

Now let’s look at how you actually apply those principles when making a loan on BTCJam.com.

Rule #1 Diversification: Make at least 50 to 100 investments.

Why is diversification so important?

Here’s a blog post showing the benefits from diversifying on Lending Club:

Try to look at it from a risk perspective. You want to invest in a way so that you minimise Systemic Risk. To make an extreme example: Giving all your money to one single person has a huge ‘systemic’ risk. Fate is unpredictable: From unemployment to an extreme case of death, everything is possible, and your money will be gone.
It would also suboptiomal to invest exclusively in people who want to buy homes in a single country. House prices are linked together by market forces. So if for example if the interest rates raise dramatically (which can happen by a single decision taken by the country’s central bank), then suddenly it becomes much harder for everyone but the wealthy people to buy houses, and prices are likely to suffer, reducing the ability of homeowners to refinance their mortgage and thus the ability to repay outstanding debts etc. Remember what happened with the subprime mortgage crisis in 2007-2008.

The big advantage we have here at BTCJam is that we operate on a global level. So we can offer much better protection against systemic risks than for example a Lending Club, who only offers to invest in the USA. Of course international markets are also linked together, but for example the correlation between Indonesia’s GDP Growth and the US GDP Growth is R=-0.09 for the time period of 1961-2008. (Source: http://ro.uow.edu.au/cgi/viewcontent.cgi?article=2575&context=commpapers)

So if a big crisis hits the USA and many people with loans lose their jobs, your loans in Indonesia likely won’t be affected.

If you invest in many small loans with good borrowers across different verticals and geographies, it is statistically unlikely that more than just a small percentage default. As long as less loans default than the average interest rate you are getting, you will come out ahead in your investing.

Assuming you invest the same amount in every listing, your return can be calculated as follows:

Actual Return = (1-Default_Rate)*AVG(Interest_Rate)

So let’s say you invest $10,000 with 100 loans that all run for 1 year and with an average interest rate of 30% per year. That means that by the end of the year would get the invested $10,000 and $3,000 of interest back. Now let’s say that 10 of those 100 default and don’t pay back anything. Then you’ve lost $1000 of your investments (plus $300 of interest you didn’t collect). But at the end of the year you still have $12,000 to your name, which is a healthy 20% rate of return.

Rule #2 Be aware of risk and high interest rates

If someone offers an interest rate that is way higher than what everybody else is offering, maybe they are looking to get a lot of money quickly and disappear, or they are bad financial planners and won’t actually be able to repay you with this high interest rate. We try to filter out as many bad apples as we can, but at the end you are still taking a risk on every loan you invest in.

Does that mean you should never invest in loans with high interest rates? No of course not. It simply means you should not put all your money into ultra high interest, high risk loans. Put some money into low interest, more safe loans, and some in riskier, more high return loans. Again, the key word is Diversification.

Rule #3 Understand the borrower

We try to make as much information available about each borrower. So that you as an investor can accurately assess what kind of person you are lending to and how likely they are to repay. So spend the few minutes to go through all the data on the profile and make an educated guess. Is this person trustworthy? Do they have a way to repay me, even if their business plan does not work out?

We hope this guide gave you some understanding of the benefits of peer to peer lending and what you can do to increase your returns and lower your risk.

We are always open to questions or feedback. Please let us know at support@btcjam.com.

You should probably check out the newest listings here!