How COVID-19 Shows That P2P Lending Is A Fairer Investment

I'm a fan of the stock market. I think most people with a long time to invest should have some of their money in it. I've written about share investing in various pieces on 4thWay, including in this guide I co-wrote: Peer-to-Peer Lending Vs Other Investments.

For all its volatility, the stock market a good thing for some of your investment pot, if you use sensible investing strategies.

Long-time readers will know what I'm not a fan of. I'm not a fan of thinking about P2P lending as something offering “easy access” to your money.

Indeed, I would go so far as to say that rapid access can even be undesirable at critical times. It's taken six years at 4thWay to demonstrate why, but I think the pandemic is starting to prove my point.

Both the above points are linked together: liking the stock market despite its volatility, and not liking it when lenders think of P2P lending as “easy access”.

Once I've explained why, you'll also start to see how COVID-19 is demonstrating that P2P lending is a fairer investment than the stock market and other investments.

Let's talk about volatility

As I said, I'm a fan of the stock market and I've not been shy here about writing what's so good about it. But relevant to my article today is showing you its weakness when compared to peer-to-peer lending, including P2P IFISA lending.

As one of my colleagues points out in the Zopa Review, ever since Zopa was founded in 2005, the stock-market has seen four down years. It could well be five after 2020.

Some of the stock-market drops were large, meaning that the average investor lost money those years.

How do crashes occur?

There are many reasons why a stock market crashes, but it's only made possible by how easy it is to sell your shares.

The stock-market is usually very liquid. That means it's easy to buy and sell whenever you want to.

There is almost always someone willing to buy, at any time. This is because people are encouraged to try to trade their way to wealth by buying and selling part-ownership of companies at high speed, attempting to take a quick profit and then attempt to make another quick profit somewhere else.

This rapid activitiy makes no sense. The average share investor who attempts to use such a manic trading strategy ends up with very unsatisfactory results.

If you think of what share investing is, this should come as no surprise. When you buy shares, you're becoming a co-owner of a business – a business partner with all the other owners. A business is a good long-term investment and not a pack trading cards.

You're ultimately looking to make money because the business is profitable, most of the time, and usually because you expect the company's profits to be higher in ten years' time than they are today.

All the investors who buy and sell rapidly make it convenient for investors with more sensible strategies. It means when, you take the decision to stop being a co-owner of a business, you can be very confident that you'll be able to do so by selling at any time.

But you're not guaranteed to get the price you want. If you – or others – are panicking at the time, you might have to suffer a steep cut in the price.

Stock-market crashes are a consequence of very easy access. If you couldn't sell easily, after just a day's share ownership, at whatever price can be agreed between two parties, crashes simply wouldn't happen.

How that compares to peer-to-peer lending

Money lending is stable for many reasons, but a big part of P2P lending's extremely low volatility is that rapid access to your cash is usually only widely available when times are calm. Most peer-to-peer lending companies won't allow you to offer to sell at cut prices in order to get out faster.

You're forced to hold onto your loans for longer, earning interest while you do so.

The overall stock market often lurches downwards; P2P lending doesn't

I said that the stock market had four down years since 2005. Over the same period of time, the average Zopa lender has seen positive returns. Not just overall, but every year, including in 2008 and 2009. Zopa is the only P2P lending company to be around as long as that, but the wider P2P market has also been highly consistent.

Based on the long history of money lending in general, we can expect that years where the average lender loses money across the entire industry will be very few, and very far, between. And the losses will be much smaller than stock-market losses.

Stock-market investors have a much wider range of results than P2P lenders

It's not just the volatility in overall results that you need to think about. The variation in results between individual lenders at Zopa – and across the bulk of the peer-to-peer lending industry – has also been very narrow.

If you look at variation of individual results within the stock market, roughly half of investors will have “beaten the market” by not losing as much as the other half in any one of those four down years. A few investors would have achieved results so much better than average that they actually made a profit. Although hardly anyone will have managed to make a profit in as many as three or four of all those down years.

On the flipside, half of investors will have lost more money than the average in those down years. Some of them will have lost an awful lot more.

In contrast, at Zopa and other P2P lending, the range of returns is far narrower, so that the overwhelming majority of lenders have made consistently positive returns, year in, year out.

P2P lending is more honest

I've found that a good check to see if an investing activity makes sense is to consider if you'd be willing to do it when buying the whole investment for yourself.*

In other words, if you were buying whole businesses and not part-ownership of a business, would you rapidly buy and sell it in the space a week or year?

This high-speed buying and selling, and the desire for being able to make instant decisions, is what leads to very steady, stable businesses having rollercoaster share prices.

Those businesses will make money for people on average over time, but many will do poorly or lose money because they haven't gone in with long time horizons in mind.

They have gone in with the idea that they can sell in an instant after a decision-making process almost as fast. And so they probably will do so. It makes no sense.

P2P lending is more “honest” in that you're forced to stay in. You can't, in a snap decision, grab half your loan back and run away with it, because you're not able to sell at any price in order to get out.

This enforces on investors the discipline not to buy and sell all the time, in the middle of an investment. This discipline is something that many share investors would benefit from.

P2P lending is more fair

For the same reason, peer-to-peer lending works out more fairly.

You don't get huge winners and losers. Returns are more evenly distributed. We're seeing this now with COVID-19, as a sizeable minority of lenders are unable to rapidly sell their loans by accepting cut prices.

When there's a downturn, panicking investors don't lose out by selling their loans for far less than they are still actually worth, creating an imbalance of winners and losers that we see in the stock market at these times.

Cash is therefore released to lenders more slowly in a downturn, not in a rush of emotion. Since downturns lead to more bad debts, it means that any resulting decrease in the rewards paid to lenders by borrowers are more evenly distribute between more lenders. The range of results betweeen them is narrower; discipline is enforced precisely because there's no mechanism for near-guaranteed liquidity.

We've often shown readers evidence of how stable P2P lending is, and bank lending was before that. That's both in absolute terms and relative to investments such as the stock market.

But this is only made possible because the rollercoaster of snap decisions is virtually taken away from people when they are greedy or fearful. To make it easy to exit early, you'd have to allow people to buy and sell loans for whatever price they wanted. That would inevitably lead to stock-market-like peaks and crashes, with unfairly harsh losses for some and ginormous profits for others.

Further reading: The Investment That’s Better Than P2P Lending.

*A funny story

Earlier in this article, I wrote “I've found that a good check to see if an investing activity makes sense is to consider if you'd be willing to buy the whole investment for yourself.”

I'm reminded of my favourite example of that, when Berkshire Hathaway's Warren Buffett disses gold in his 2011 letter to shareholders:

Warren Buffett on gold

“Gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

“Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At
$1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.

“Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

“A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.”