Diversifying A Short Term Investment Portfolio: Peer To Peer Lending

By Author: Scott Staudt
Total Articles: 91
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Balancing a portfolio through a mix of assets is the hallmark of a well designed investment plan. Most investors will try to have a mix of short term assets with long term assets, and floating rate investments with fixed rate. Domestic investments might be balanced by international investments, etc.

Short term investment portfolios will usually include some investments in loans of one kind or another. Treasury bills, which are a component of most portfolios can be considered the ultimate loan: to the government. Another common short term investment is in Certificates of Deposits or Money Market Funds. Both of these types of investments can offer liquidity and flexibility, but the returns are usually low.

Now there is a better opportunity to invest in short term investments in loans, that can offer higher returns than traditional bank CDs or T-bills. This new alternative is peer to peer loans, which permit investors to invest in loans directly to consumers, which carry a higher rate of return than other traditional short term investments.

In addition, to add further diversification, peer to peer lending ...
... creates an entirely new asset class, consumer loans, to a portfolio that may be limited to stocks and bonds and perhaps investments in bank CDs or savings accounts.

The peer to peer loan philosophy is a simple enough one. A specially designed site matches borrowers who are interested in getting loans with lenders who are seeking a better yield on their investments. These lenders design a unique loan portfolio by looking over all of the loans available and choosing the ones that match his investment goals.

One investor may prefer a very conservative loan portfolio in his short term investment strategy and just choose those loans with the highest rating and the lowest loss ratios. This conservative outlook could be further diversified by spreading the investment amount over many loans. The combination of choosing exact rating and rates, and spreading loans out over many borrowers creates a perfectly tailored portfolio. An investor who was going to lend $5,000 could pick 50 or more borrowers to lend to, and spread the risk very widely. The yield on such a conservative investment would be lower than that of a more aggressive mix of loans, but the investor has the choice.

Peer to peer loans are usually 3 year amortizing loans. Monthly remittances of principal and interest by the borrowers are paid quickly to the lenders; lenders don't wait until the loan maturity to recoup their investment. The rates on the loans are fixed, which is an attractive feature in a market that sees CD rates continue to fall.

The way it works is fairly simple. The online peer to peer loan site allows prospective borrowers to list their personal profile and loan requirements and the site will list their credit information. These listings are available for lenders to look over, and any investor/lender can choose any mix of loans to construct a loan portfolio that suits his strategy for short term investments. In this manner, an investor meets his goals of risk/reward ratio, short term investment portfolio diversification with a new asset class, and further diversification by breaking that investment into many small pieces.
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