Many of us in the UK have worked hard for many years, and as the years pass, we find ourselves looking eagerly toward retirement. We’ve long viewed an annuity contribution as the rock upon which our guaranteed retirement income is founded during our retirement years, but that rock appears to have crumbled somewhat with the “pension freedoms” recently implemented. While we are no longer required to purchase an annuity, the expected decrease in participation threatens the financial health of the remaining annuities.
Granted, we are now free, at only 55 years of age, to spend down our annuity accounts as we see fit, with minimal penalty for doing so. But that freedom has come at a price – the historic drop in annuity rates, greater than any in the 30-year history of the annuity accounts, that has eroded the return we will realise on our investment over the years. Naturally, investors who are approaching – or, for that matter, who are planning ahead for a distant retirement – are looking for investment tools that will offer them greater wealth and security. And looming large among the available tools are peer-to-peer loans, or P2P.
What is all the buzz about P2P?
The basic idea behind P2P lending is far from new, and actually predates banking as we know it. Individuals have long sought out other individuals for loans, but P2P is a bit more regimented than borrowing a few pounds from your uncle George or the wealthy bloke down the road. The relatively new industry is based upon services that match up borrowers with lenders while eliminating the banks altogether, somewhat akin to an online dating site, albeit seeking money, rather than romance. Prospective lenders register with sites such as Zopa, Funding Circle, RateSetter, or any number of other P2P services that are rapidly emerging, indicating how much they can make available for loans to individuals, businesses, or other organisations, and what their requirements are to qualify for loans.
Prospective borrowers also register on the sites, and state their requirements and qualifications. The approval rates can be significantly higher with P2P services than with banks, which have been quite rigid in their lending policies in the wake of the financial crisis. While this is a definite plus for borrowers, it does raise a bit of a red flag for lenders, as the default rate is somewhat higher than the rate of bank loan defaults.
Where does the individual investor fit into this process?
Investments in P2P loans typically offer a higher return, despite the fact that loan interest rates are competitive with – and often lower than – the rates offered by banks. This is possible for a number of reasons, among them a potentially less-stringent borrower qualification process, the lack of physical infrastructure. As with any investment offering a higher rate of return, there is a corresponding increase in risk to investors, with . The P2P services are up-front about the greater risk, the absence of coverage by the Financial Services Compensation Scheme (FSCS) that is standard with banks looming large among those risks. Prospective investors should take the admonition to heart.
Is the higher return worth the greater risk?
That’s the big question, isn’t it? So big, in fact, that it cannot be answered in a simple article, and the answer won’t be the same for every individual investor. While you definitely want as great a return as possible on your money, especially given the drubbing that annuities are taking right now, how well could you handle it if a borrower failed to pay off their loan, leaving you with nothing to show for your investment? Frightening thought, isn’t it?
As with any investment, it is up to the individual to have a realistic idea as to how much risk they can tolerate. The help of a qualified financial advisor is essential in reaching such an assessment, as they are likely to consider numerous factors that might never occur to you. At the very least, a financial professional will likely advise you to diversify your investments, so as to afford yourself of the higher earning potential of a higher-risk investment, while retaining a significant portion of your savings in a more secure vehicle that offers a lower rate of return. Millions of people, not only in the UK, but worldwide, probably wish they had incorporated such a safety net in their investment portfolio before the financial crisis hit. Many of those who opted solely for higher return despite the risk saw their entire savings evaporate in the same amount of time it took for the bubble to pop.