Peer-to-Peer Lending Vs Other Investments

In this guide, we explain how peer-to-peer lending performs when compared against stocks and other investments.

Here's a short summary of what you'll learn

Useful investments for most people are 1) Savings accounts, 2) peer-to-peer lending, 3) buying your own home and 4) the stock market.
Bonds and gold have been poor “middle ways” between savings and shares.
Peer-to-peer lending has a better risk-reward profile over the medium term.

Before 2005, when friends and family used to ask 4thWay founder Neil Faulkner for some tips on what to do with their spare savings and income, he used to suggest they get a mix of three savings and investments: savings accounts, buying a home and the stock market.

But peer-to-peer lending has long now been a standard fourth suggestion. (The 4thWay. Get it?)

All four types of investment serve a very specific purpose that cannot easily be replicated. Let's compare peer-to-peer lending to the other three investments and then show you why peer-to-peer lending now makes this key list of basic, good investments that everyone should consider:

1. Peer-to-peer lending vs buying your own home

Buying your own home will usually work out very well for you in the long run, provided your financial, home and work life is stable enough for that commitment.

You're replacing one ever-rising bill – rent – with a bill that gets easier to pay as time goes by – a mortgage. This second bill should be over in 10 to 40 years, too, whereas rent is never-ending.

Clearly, this is a very long-term goal requiring a lot of certainty in your life. You can't easily buy now down in Mallorca and then decide to go for a new life in Berlin six months later.

2. Peer-to-peer lending vs savings accounts

It's not likely your savings will suddenly lose 15% of their value or become difficult to withdraw in full in a hurry. This is why savings accounts have always been the place to keep money for emergencies. It's also why we use them to save for expenses that are coming up in the near future.

Savings accounts also make sense if you have a specific goal to save for over few years and you need certainty that the money will be there at the end.

As a complete contrast to other three investments on this list, the flipside with savings is that leaving substantial amounts in cash accounts over the medium or longer term is almost always very high risk!

We will probably continue to see the value of our savings absolutely smashed by the rising prices of goods and services we buy, because banks won't pay us enough savings interest to compensate. Our spending power goes right down.

3. Peer-to-peer lending vs stock-market index trackers

As with the other investments, the stock market has really proven its worth. It's always been the place to invest if you want to have a good chance of beating rising prices over a long period of time.

It's also been one of the key places to look if you want to grow your wealth substantially.

Particularly investing regularly, as cheaply as possible, perhaps by spreading your money and risks between six to ten index trackers (and many hundreds of companies), is likely to reward you with satisfactory returns.

Unfortunately, lots of people don't do share investing this way. Yet, if you deviate from a simple and low-cost strategy like index tracking, you have both higher long-term risks and most people get far lower returns as well! It goes to show that higher risk does not always mean higher reward.

Even if you lend in index trackers, if you've ever seen stock-price charts, you'll know how bouncy the results can be. With short-term stock investing full of those risks, you must to be prepared to hold on for the long haul, if necessary.

The best research on share investing shows that not even the five-year or 10-year horizons that many fund managers espouse are sufficient for lowering the risk of disappointing and below-inflation stock-market returns; you need to be thinking about the possibility of share investing for 20 years or longer.*

Inflation-beating returns with lower risk over shorter periods

Until peer-to-peer lending arose, there had been no satisfactory middle way between savings accounts and shares. That is, no investment offering to nicely counter inflation and usually earn a premium, but without risks that can force you to commit your money for a very long time.

How does peer-to-peer lending compare to investments outside this top four?

Bonds and gold are probably the two most used types of investments, or the most famous, that aren't in this top four:

Bonds

Bonds are usually considered the main “middle” way, but unfortunately bonds have a number of weaknesses that have revealed themselves in their disappointing results.

Bonds are a type of loan that investors make to governments or (usually large) companies. If you have a pension and you don't remember what you're invested in, you probably own some bonds through bond funds.

Bond funds have their moments of glory. But the rewards of investing in bonds have generally been low. Your chances of beating rising prices aren't a great deal better than savings accounts.

Even if you could invest in bonds at no cost, the best historical records* show that you could have invested regularly, month after month, with shocking results. You could still very easily have found, after 20, 30 or more years, that your investments can buy you less in the shops than when you put the money in.

The reason was that, like savings accounts, shop prices rose too fast compared to your rewards from owning bonds.

And that's before deducting costs. After paying investing costs every year, bonds really start to look pretty ugly as a “middle way”.

If you're investing for incredibly long time periods, you should expect to get a decent premium above rising prices for locking your money up for so long. Yet bonds are not a good place to look for that.

In addition, if you're investing for shorter periods – say, five to 10 years – you have a real chance of losing more money when bonds fall. The roller-coaster isn't as severe as the stock market, but the chances of being less well off are higher.

Bonds really haven't lived up to expectations over much of the past 120 years.

Gold

Gold is a favoured place for rebellious, greedy or panicking investors to turn.

This is surprising to me, because this “precious” (but mostly useless) metal has a debatable record as a store of value. Here's a quote attributed to Buffett by The Times of London:

“Gold gets dug out of the ground in Africa, or some place. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Such figures as H.G. Wells and even nineteenth-century newspapers have said similar things.

After the markup costs in purchasing and selling, not to mention possible storage and insurance costs, you'll have been lucky to have matched rising prices over the long run. It's not even a reliable place to protect yourself in the short run against a sudden big jump in inflation.

In addition, the roller-coaster of up-and-down prices is as severe as the stock market. Possibly even more so, according to this New York Times article by N. Gregory Mankiw.

If you read that piece, remember that N. Gregory is referring to returns from gold before your investing costs are deducted. After costs, the results are even worse. N. Gregory also has a slightly different opinion to Buffett or 4thWay on gold: he grudgingly suggests you might hold 2% of your spare money in gold.

So, with gold, you're getting a lot of uncertainty and risk for very little long-term safety. The risk-reward profile compared to holding shares for the long term, frankly, sucks, and short- and medium-term gold investments are a huge risk due to its volatile price.

Peer-to-peer lending vs the rest in the middle ground

Peer-to-peer lending fills this gap in the middle that is not well serviced by savings accounts, the stock market, bonds, gold or any other investment.

It's why banks, hedge funds and other financial institutions are lending alongside individuals through the same websites and why financial advisers are increasingly advising clients to lend, too.

Bank lending, and now peer-to-peer lending, which is the same thing just done by ordinary people, has provided steady returns over shorter and longer time periods for a very long time. (At least, it has when banks have stuck to bread-and-butter lending rather than their sub-prime mortgage nonsense!)