The Right Split Between Savings, P2P, Shares, Property
This article is about how much you should split between savings accounts and peer-to-peer lending, and also shares if you want more diversification further up the risk scale.
I also discuss the money you might put into buying your own home.
Those are what we here think of as the four main ways to save and invest, with P2P being the new one making the name “4thWay®“.
How much to keep in cash savings
You need enough money in your current account, savings accounts and cash ISAs for your short-term needs as well as for emergencies.
How much you want to put aside for emergencies is up to you and specific to you, although generally I think it makes sense to have enough to cover several months of your household expenses.
Under your “emergency” savings, you might want to include a small, self-made “bad-debt provision fund”. That might be as low as 4% of the amount you lend if you stick to lower-risk P2P lending, and 10% if you like to take a lot of chances. That's totally optional though.
If you have excess cash over your emergency and short-term needs then you have a choice to make.
If you want to protect the value of your savings from being eroded by inflation, savings accounts are likely to let you down. Even if you regularly shop around for the best deal, the savings you put away today will be able to buy you less in five to 10 years' time.
On the flip side, if you absolutely need to have more cash available in as short a period as 3-5 years and can't take any chances at all with it, you might need to keep a lot more of your spare money in savings accounts.
The risk of a large, sudden loss is mostly limited to extreme events, such as very high inflation or the government raiding our savings to pay its spiralling debts!
How much to lend through P2P
Beyond your emergency and short-term fund, if you want to protect your wealth from inflation, the best way is to invest it.
Investing comes with risks of making short-term losses but you are far, far more likely to preserve and grow your pot so that you can buy more with it despite rising prices.
You don't have to go all that high up the risk scale to have a great chance of achieving this goal. This is where P2P lending fits in.
Provided you go for the lower-risk P2P lending opportunities, you can easily earn more interest than with savings accounts, even after taxes, and you can almost always beat inflation. When you don't beat inflation, you will catch up again on the other side.
You do have to be prepared to lend your money for some years. This is just in case a huge recession or other event occurs during your investment period. In that event, you might need either a little time to recover or the situation might make it difficult for you to withdraw the full amount of your loans swiftly.
(Lenders haven't needed any time at all to recover from recessions so far. But each downturn is different.)
How much to put into shares
If you're willing and able to invest for at least 10 years and preferably 20 then the stock market is another excellent place for you. It's currently, on average, further up the risk scale again than P2P lending but it could potentially be more rewarding.
At the very least, it will offer even more diversification, which can offer additional protection to you.
The split between P2P lending and shares
Assuming you're able to invest for at least 10 years, the amount you want to split between these two forms of investment could be personal to you.
I think that we could use the “father” of modern investing's technique to decide. I”m talking about Benjamin Graham, author of investing classic's such as The Intelligent Investor and a fantastic investor in his own right.
Graham suggested a split of 50/50 between shares and bonds. We at 4thWay® have never considered bonds to be a great investment for the majority of people, since, historically, the chances of losing to inflation even when investing for very long periods is simply far too high.
This risk has only increased since Graham's time, due to bonds now mostly being bought through funds. This means that you're susceptible to price fluctuations too.
If it wasn't for the bond-fund structure, the average peer-to-peer loan might be further up the risk scale than bonds. But, instead, peer-to-peer lenders probably don't face higher risks overall – but earn noticeably better interest rates. So P2P replaces bonds.
Graham also said that when you're certain that shares are deeply under-priced then you might tip the balance to 75/25 in shares' favour. Conversely, to apply Graham's strategy using P2P lending, if the risks and interest rates on P2P lending are clearly highly favourable at a given time, then you can put 75% into P2P instead. Or vice versa.
How much to put into your own home
Buying your own home is another fantastic investment, especially since it largely replaces the “dead” cost of rent. And after repaying your loan to buy the property, your housing costs plummet.
How big – and how expensive – a home you buy depends on your needs.
But when to buy depends on a few simple rules:
You have to strongly believe that you'll be in a stable financial situation for years to come.
You have to be willing and able to stay in the same property for many years, in case there's a property-price crash after you move in.
You have to be able to easily afford the monthly mortgage payments, especially if interest rates were to rise considerably.
The price has to be right. The best measure is to see how much you would pay for the property if you were renting versus how much you'll pay each month in a mortgage by buying. As a rough guide, if the mortgage payments aren't more than about 1.5 times the rental payments, your purchase is very likely to pay off in the long run – even taking all owning/renting costs as well as lost savings interest into account.
This page was adapted from our UK website. The original is here.