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Investment Diversification: How a Portfolio Can Mitigate Risk

One of the biggest apprehensions we hear from Kiwis looking into peer-to-peer investment opportunities is the level of risk they're entering into. It's understandable too; if you're putting upwards of $10,000 into an investment, you want to be sure that your funds are safe and as guaranteed as possible to deliver returns with minimal risk.

Some common questions we come across include:

  • How safe is my investment?
  • What happens if the borrower doesn't pay their interest?
  • What happens when there is a shortfall when the loan is repaid?
  • If a loan is in default, do I get any default interest?

There are a lot of things we do at Southern Cross Partners to mitigate risk, including supporting your investment with a first mortgage registered against a piece of Real Estate, and allowing you to choose the loan to value ratio that best suits your investment risk profile. We also ensure all properties are fully ensured by being noted as an interest financial party on the insurance certificate.

That being said, there are certain popular investment strategies that you can employ to add another layer of security and risk mitigation to your investments. One of the most common of which, is building a diverse investment portfolio.

In this blog, we'll unpack what investment diversity actually is, what that might look like for you (the investor) and some of the benefits of this strategy. As always, make sure to seek advice from your financial adviser before making any decisions regarding your investments.


What is Diversification?

If you've ever heard the statement 'don't put your eggs in one basket', that quite accurately summarises the idea of diversification. As explained by P2P market data;

"Diversification is a risk management technique used to create variety in the investments of your portfolio."

The idea is to create a portfolio of different investments, so that should one fail or fall into the red, you won’t feel the full impact of your losses at they will be cushioned by your other non-fluctuating or successful investments within your portfolio. Through multiple and diverse investments, long term, your wins and losses equate to an even or positive outcome, mitigating the risk of investment.


How Does Diversification Look in Peer-to-Peer Investing?

In a stock market investment, diversification tends to mean buying shares from companies that are in no way related. For example, if you were to buy shares in the medical science industry as well as a number of other industries, if your medical science investment was to dip, all of your other shares in other industries could remain unaffected. If all of your investment money was in the medical science industry, you'd stand to feel the full impact of the market dip and have nothing to cushion your loss.

In the peer-to-peer investment industry, diversification might look slightly different. The ways in which you might be able to create a diverse portfolio might include the following:

Spread your investments across different loan terms

Depending on what kind of loans borrowers are looking for, there may be a range of loans available for different loan terms. A good place to start diversifying is by spreading your investment funds across a range of loans of varying terms. This way, your money is never tied up for an extended period of time in any single loan, and your initial investment funds will be returned to you incrementally as each loan is repaid.

Invest in different loan types

Typically, each different P2P platform tends to focus on a specific type of loan or loan market. Similarly, to the risk we identified above in investing in one industry in the stock market, the P2P loan industry can experience the same problem. For example, some P2P businesses offer personal loans, car loans, business loans or property development loans ( for more info you can check out our blog on why people borrow short term loans, here). Within each of these categories there is some level of market risk.

For example, if the property market was to crash, this could mean that a property developer does not get the valuation expected when the loan was taken out and may not repay the full amount. In turn, if the economy was to fall, this could have a number of business implications and may mean that some borrowers' business loans go bust. While it's very difficult to predict what might happen in the future, it is possible to protect yourself against the impact of these risks by diversifying the market you're investing in.

Spread your investments across different asset classes

When looking at your investment strategy as a whole, it's also important to consider diversifying across multiple asset classes to mitigate risk. That means considering multiple types of investments, from bonds, stocks, rental properties, term deposits and property backed peer-to-peer lending. A balanced portfolio with diversification across uncorrelated asset classes could reduce the financial ramifications if one of your investments were to fail.

Here's an example of what a holistically diverse investment portfolio might look like.


Interested in adding Peer-to-Peer investments to your portfolio?

We're here to help. If you have any questions or are interested in peer-to-peer investing, get in touch with one of our advisers below.