Every investment involves a risk. Some investments are riskier than others. For that reason, it’s important for investors to perform some due diligence to assess the risk and minimize it to some extent.
While it’s impossible to minimize every risk to zero, there are some ways for investors to analyze risk and manage it so that it doesn’t end up eating your profile or costing you more to make an investment than you gain in returns.
With stocks and bonds, you understand the risks. The market is volatile, there are sharp ups and downs in stock prices and indexes, and brokers have fees. You factor all of that into your investment portfolio.
Real estate also has its risks. Buying and selling may lend itself to losses if you buy a property for too much or fail to access potential repair costs accurately. Renting has its own potential risks that might include buying the wrong property in the wrong neighborhood or not properly assessing the cash flow. Once you identify the potential risks, you can take measures to reduce that risk and protect your investment.
Marketplace Lending Also Has Its Associated Risks
- Platform Risk — It’s important to choose the right platform. Because marketplace lending is still young, there is a tendency to get excited about a deal before the proper due diligence has been made. Marketplace lending platforms do not have long track records because of the innovative nature of the industry. On top of that, there are a large number of investors and fewer borrowers, which means the competition is on the supply side of lending. Make sure you do your due diligence on the platform to ensure it is strong financially and has controls in place to minimize your financial risks, especially in its underwriting practices.
- Market Risks— Marketplace lending is as subject to law of supply and demand as anything else. What will happen if there is a sudden influx of borrowers? What if the number of marketplace lending platforms declines due to mergers, acquisitions, and insolvency? The market is very hard to control. If you don’t understand the forces that affect it, then it can be very hard to assess the risks involved in marketplace lending. Make sure you educate yourself.
- Credit Risks— Just as a bank must assess the credit risk of a borrower, investors in marketplace lending must learn to assess the credit risk of borrowers. Sometimes, a good risk turns into a bad deal. It’s the nature of the game, but good underwriting practices and proper due diligence can spot bad credit risks before the first dollar is invested.
- Portfolio Risks— What percentage of your portfolio is liquid? How much are you investing in one asset class versus another? You know the old adage about putting all your eggs in the same basket? It applies to marketplace lending.
It’s important to understand the nature of risk and to assess risk properly. The best defense against too much risk in marketplace lending is sound underwriting. At Sharestates, we vet every investment and each real estate developer so that investors can make the best possible decisions concerning their portfolios.