P2P Lending vs. Bonds: Which Is the Better Investment?

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In the previous article within this P2P lending vs. traditional financial instruments series, we looked at how P2P lending compares to stocks. We concluded that P2P lending can be a great investment opportunity for beginner investors and those with less capital and a shorter investment time horizon. We also highlighted that P2P loans are a superb complement to stocks, counteracting their volatility with secure and steady returns. In this respect, they might provide a viable alternative to traditional “safe assets” such as savings accounts, gold, and the most popular of all – bonds. Herein, we’ll dive deeper into how P2P loans compare to bonds and whether they can indeed supersede bonds as the superior safe investment.

Differences and Similarities of Peer-to-Peer Lending and Bonds

Bonds are much more similar to P2P loans than stocks. Both are debt instruments and generally produce a fixed income return over a set term. There are some key differences though, such as:

  • Investing in bonds, you are lending your money to governments or (usually large) companies. Investing in P2P loans you make your money available to individual borrowers or small and medium-sized enterprises (SMEs). 
  • The bond issuer typically pays the interest at predetermined intervals – usually annually or semi-annually, but returns the “principal” (i.e. capital invested) when the loan ends (or “matures”). With P2P loans, you tend to receive an instalment of the principal, along with the interest, monthly, until the whole amount is repaid.
  • Bonds tend to have longer maturity (around 10 years on average). P2P loans can last from a couple of months to roughly three years.

Pros: How can P2P Lending be a better investment than Bonds?

Higher returns

Most P2P lending platforms offer return rates between 8 and 10 per cent. Although hitting profits even above these numbers is surely possible if you build your portfolio carefully and have some luck, the historical records show somewhat less impressive results. According to the Marketplace Lending Index, the average annual returns from P2P lending have stood between 4.5 and 8 per cent annually. 

Having this cautious estimation in mind, this is still way better than most bonds. Of course, this depends on the bond type. High-yield bonds can bring some more rewarding returns, but there’s a reason why they are often called “junk” bonds – the risk isn’t, arguably, worth the promise of “high yields”. On the other side of the spectrum, there are saving bonds (which are not actually bonds but saving accounts) and safe government bonds. However, with these (admittedly extremely safe) investments, you’re unlikely to even beat the rising prices (i.e. the real return rates tend to be negative). Probably most comparable to P2P loans are corporate bonds – but these also lose the return rate competition, with average returns of 3 to 5 per cent.

Security

Not only do P2P loans outperform corporate bonds in terms of expected returns, but also provide ways to secure your investment. Bonds are generally unsecured – if the company goes bust, you can lose your capital. This is of course much less likely or impossible with safe government bonds or savings bonds, but remember – that’s why they actually bring you a net loss.

Investing in P2P lending, you can pick and choose loans from different risk categories, from creditworthy businesses to higher-risk ventures. But most of all, you are provided mechanisms that can alleviate or shift the risk away from the investor to the platform. Some platforms offer the option of buyback guarantee, in which the platform commits to the full repayment of debt in the case of the borrower’s default. Others operate bad-debt provision funds – an emergency pot of money used to repay the bad debts in time of distress. New inventions in this area are coming up as well – for example, at HNW Lending, its directors co-invest in every loan and take the first loss position (i.e. if a debt isn’t repaid in full, they lose money before the investors do).

Better cash flow

To receive the interest pay-out on bonds, they have to be held to maturity – if you want to sell a bond, you can incur a loss. Given the 10-year maturity of bonds (on average), this means your money can be frozen for a really long time. With P2P lending, not only you won’t have your capital tied down for long periods, but you’ll also receive regular monthly instalments, ready to be reinvested right away. In the case you are in real need of withdrawing your funds quickly, you can sell your loans on a secondary market and access your money relatively early most of the time.

Few barriers

As with stocks, actively investing in bonds (rather than putting your money in bond funds), will require you to use services of a stockbroker or bank, whereas, with P2P lending, you can open an account online, transfer some cash and start investing. Investing in bonds also typically requires a much higher initial investment.

The social side

On average, we are increasingly conscious as consumers. We are more likely to buy products or services from companies that respect their workers’ rights, care about the environment and give back to the communities. We support local entrepreneurs and contribute to local charitable initiatives. P2P lending can be seen as a piece of this puzzle – instead of giving our money to large corporations that we have no connection to at all, we can help out small business owners and struggling individuals. And if you make money at the same time, it does seem like a win-win.

Cons: Where do bonds score higher?

Risk

Although P2P lending platforms offer a variety of risk-mitigation mechanisms (from credibility checks, through portfolio diversification, to buyback guarantees and provision funds), at the core, they are a riskier investment than bonds. After all, a loan default is much more likely than a company, let alone a government, going bust. P2P loans also tend to be unsecured, meaning there is no collateral to back the loan. You can read more about expected risks and ways to mitigate them, here.  

Time commitment

If you decide to invest in bonds, you buy them and can literally sit back for a decade not worrying about how to manage your capital. Some P2P platforms (e.g. Mintos) minimize the required involvement by offering auto-invest strategies, in which case you only have to input your preferences and your money will be automatically allocated in loans meeting set criteria. However, in general, investing in P2P loans, especially if you want to diversify across different specialised platforms and different types of loans, you’ll need to spend a considerable amount of time on choice, analyses and tracking of your investment.

Conclusion: Is P2P Lending the best investment choice?

Some P2P lending features clearly distinguish them from both stocks and bonds – it is easier to actively invest in or provide a more socially-friendly approach. In many cases though, P2P loans can be found somewhere in the middle – they are riskier than bonds but less risky than stocks, provide moderate returns, etc.

We compare the key features of all three assets in the table below (to simplify, we focus on corporate and safe government bonds).

Based on this, here are some key takeaways from the P2P loans vs. bonds and stocks comparison:

  • P2P can be a great substitute for bonds. Provided some risk-mitigation measures like loan diversification are in place, P2P loans offer significantly higher returns than bonds, but of course also come with a higher risk. Adding to this the other benefits (steady monthly cash flow, ease of active investment, the social side), it could be considered reasonable to swap at least a part of your bond investment for P2P loans. 
  • P2P lending can complement stocks. Stocks provide long-term returns that are hard to beat, but also bring plenty of short-term volatility, which can be to an extent mitigated with a de-correlated, fixed income asset such as P2P loans.
  • P2P lending is the place to learn about investing. Low capital requirements, user-friendly platforms, possibility to invest actively – all this makes P2P loans a perfect starting point to learn about investing principles and develop good habits.