Peer-to-Peer Lending Rebalancing Strategy

How do you rebalance your P2P loans and other investments when parts of your portfolio do better than others?

For example, when your share investments perform very well and you want to split your wealth more evenly again between shares and P2P loans. Or when your high-risk P2P loans do much better or worse than expected, and you want to shift some money around to balance with the low-risk loans.

Throw away some IQ points

Before you think about your rebalancing strategy, consider this.

(Probably) the greatest living investor, Warren Buffett, was once asked a complicated mathematical investing question by a fund manager.

Warren's response was: “Take two dozen of your IQ points and give them to someone else. You don't need them.”

He was making a point that he makes quite often: good investing is not PhD maths. It's not a complicated formula. It's certainly not pinning your decisions down to an accuracy of fifteen decimal places.

Because it's impossible to evaluate the future returns of your investments that closely. Indeed, as Warren says, that mathematical accuracy gives you a feeling of safety and security that just doesn't exist.

In addition, if you attempt to maintain that accuracy by constantly, precisely rebalancing your P2P loans and other investments, it costs money to do so. Warren and many other investors have learned that it's those constant small costs that totally kill off all the rewards you make from investing (or lending).

Peer-to-peer lending rebalancing isn't rocket science

One aspect that maths buffs, including geeky professionals, get way too involved with is their strategy for rebalancing their wealth.

Say you start off by putting 40% into safer peer-to-peer lending companies, 10% in higher-risk P2P loans and 50% in the stock market.

I don't know what will happen to your own portfolio. But let's just say that after a while the amounts have changed, due to the overall returns of your investments. You now have 60% in the stock market, 35% in safer peer-to-peer lending companies and 5% in high-risk loans.

The initial balance you desired has already gone.

Warren's views on reallocation

Warren once wrote: “Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.” This was in his 1990 letter to his shareholders.

By “stay-put behavior”, Warren was referring to the fact that he and his business partner, Charlie Munger, don't sell shares or trade them for something else unless there's a really great reason to.

Warren and Charlie have both talked a lot about the costs of being an “active” investor. Buying and selling shares eats away at your gains, because you keep paying more costs.

On average, the patient investors get richer at the expense of the more frenetic traders.

The same is true with all investment types, including peer-to-peer lending.

There are exceptions. A couple of the safest peer-to-peer lending companies, like Wellesley & Co. and Landbay, will let you exit a loan early at no cost.

But for the most part there are either exit costs, loss of interest, or you might have to bribe another lender to buy you out.

So, as a general rule of thumb, it makes sense to reallocate the same way Warren does.

How does Warren rebalance his portfolio?

Warren doesn't normally sell some shares when a holding rises “too much”. Instead, he takes any regular cash his company earns on its investments and invests that somewhere else.

You can do the same. When you're paid interest, you can choose whether to re-lend through the same peer-to-peer lending company in the same sort of loans, or to move that new income you've got elsewhere.

We can do what Warren can't

We peer-to-peer lenders have two extra ways to rebalance our portfolios that aren't available to the so-called “Oracle of Omaha”. Both of them are free of additional trading costs.

Firstly, we can drip-feed spare monthly income we make from our salaries into whichever loans (or share holdings) we like. We can correct imbalances this way.

In addition, peer-to-peer lending is, by its very nature, easier to rebalance than shares. This is because borrowers keep paying us back on a regular basis, and we have to go to the effort of re-lending it again. (Selfish borrowers!) But the silver lining is that we can decide for ourselves where to put that cash next.

Going down to the next level

You might be interested in doing your peer-to-peer lending rebalancing strategy at a more detailed level.

For example, if you have 20 shares in your share portfolio (or you might have half a dozen share funds), you might want to even out your holdings after a while. Because some will have done better than others.

It's quite common to “top-slice” the better performers, because their prices have risen and, the more a price rises, the higher the risks are that it will fall. You might also add money to underperformers, since they're now cheaper and less likely to fall – provided you're confident in your selection strategy and that the shares will turnaround.

Regarding P2P, you might want to rebalance so that, say, your loans through RateSetter make up more of your portfolio again, to better spread the risks. Or you might want to take some of your Funding Circle  repayments and move them elsewhere.

Consider your overall strategy

While I'd generally suggest that you don't rebalance by exiting loans and re-lending elsewhere, how you rebalance – and whether you do it – depends on your overall strategy.

If you have set minimum interest rate limits, for example, it could be sensible to stop all further loans through one P2P lending company if the rates have fallen too far.