In 2017, I started to venture into P2P financing with Funding Societies, one of the six regulated P2P financing platforms in Malaysia. It could be a viable method to generate higher returns from my capital as compared to just placing it in a fixed deposit account.
I chose Funding Societies as my preferred platform as I had learnt that the team is meticulous in filtering its SMEs through site inspections of their business premises and credit assessments. They summarised their findings in a report, and I can quickly assess each SME before lending my capital to them.
It is now April 2019. I had accumulated close to 2 years of investing experiences with Funding Societies. I checked my account and found that I had earned small net profits from my ventures.
I did some thinking and had reflected upon my ventures into P2P financing. From it, I realised that this investment vehicle might not be suitable for all. Thus, in this article, I’ll like to share my thoughts on, whether or not, P2P financing is an appropriate vehicle for you to consider investing into for better returns.
As such, here are five things to consider before investing in P2P financing .
For Funding Societies, the returns offered from its pool of investments could be as much as 14% per year after service fees, which are payable if you have collected your principal and interests. Your returns had been calculated, and they present it in a summarised report.
I find this attractive for two reasons. First, the returns are pretty high. Second, I would pay fees to Funding Societies only if I make money. I think this is fair.
I started my venture by depositing RM 1,000 into my Funding Societies account and had the option to begin investing with as low as RM 100 per investment. As such, it is very affordable and suitable for any investor who intends to start with small capital.
With Funding Societies, I can choose to invest my capital to its pool of SMEs in the form of business term financing or invoice financing. The borrowing term ranges from 1 to 18 months.
For instance, if I opt to offer business term financing to a SME where it has a duration of 12 months, I would recover my principal sum and earn its interest through 12 monthly instalments over the next 12 months.
During the 12 months, I’m not allowed to demand full repayment of my remaining principal sum from the borrower. Unlike fixed deposits where I could recover my principal amount in full after cancelling them, the capital invested through P2P will have to go through the whole cycle before coming back to you. In other words, if I invest in a SME, my capital will be tied up with him for the entire duration of the financing arrangement.
Thus, I believe it is best for you to invest only if you have excess cash-in-hand as the investment into P2P financing is ‘not-so’ liquid.
#4: Default Risk
As of April 2019, Funding Societies has disbursed RM 1.57 billion in financing to SMEs. It has recorded a default rate of 0.85%. I think it is a great achievement and it arises from the team’s efforts in improving the quality of its pool of SMEs since its launch.
But defaults do happen, and they will put a dent to your return on investment (ROI) in P2P financing activities. I learnt about this as I have five defaults out of 180 investments made over the last two years. Here, I’ll share the impact of default on your investment into P2P financing and a strategy to mitigate it.
The Default Impact
Supposedly, you intend to invest RM 10,000 into P2P financing. You split your RM 10,000 into ten investments to spread out your risk.
Let’s assume that each investment:
- Is worth RM 1,000.
- Carries a net interest rate of 10% a year (after deduction of service fee)
- Have a duration of 12 months.
Thus, you expect to make RM 1,000 in net interest income from your capital of RM 10,000.
- 9 of the 10 SMEs have paid in full. You recovered RM 9,000 in your principal sum and earned RM 900 in interest income. Hence, from your 9 faithful SMEs, you collected RM 9,900 in total.
- One SME had defaulted its payment at the 11th month after it has settled its first 10 months of the repayment scheduled. You had received RM 833.33 in capital repayment and RM 83.33 in interest. As a result, you incurred a loss of RM 83.33 as you lent RM 1,000 to this SME.
Thus, your entire collection after one year of investing is RM 10,816.67, which consists of RM 9,833.33 in the capital and RM 983.33 in interest income. The actual return is 9.83% from your capital of RM 10,000, which is lower than 10% expected.
A default may occur despite your best efforts in selecting a SME.
So, is there a strategy to minimise the impact of one default to your portfolio?
I think the best strategy is to spread your investment evenly so you will experience the industry general default rate. If it is 0.85% as indicated on the Funding Societies website, your portfolio exposure should be at the same risk too. It should work theoretically. However, in reality, there is another problem which happened to my portfolio.
Currently, there is more demand for investment compared to the supply. I set my auto-investment to be RM1000 per note, but I could hardly get full RM1000 allocation for each note. As a result, my exposure to each note is not even. Some are as low as RM150. Meanwhile, a handful will be at RM1000 allocation. As a result, the default rate seen in my portfolio is higher than the statistic.
So it is important to find the sweet spot for note allocation. I suggest that you limit your per note investment exposure to RM100 or RM200 at most, at maximum, per SME. This is the current “sweet spot” that can reduce the impact of one default on the overall ROI of your portfolio.
#5: Tax Bracket
Interest income earned from P2P financing is taxable under the Income Tax Act (ITA) 1967 as it is not tax-exempted.
If your chargeable income is above RM 70,000 where your maximum tax rate is 21% and above, your final returns from P2P financing may not be as appealing as you need to pay 20+% in income tax for interests earned from this investment.
However, if your chargeable income is RM 50,000 and below where the tax rate is 8% at maximum, then perhaps, it is more worthwhile to consider P2P financing as an alternative investment.
Conclusion: Is P2P Financing a Suitable Investment Vehicle?
Admitably, my ventures into P2P financing are not the best yielding as compared to other asset classes such as businesses, stocks, and properties. But still, I had learnt a lot and gained invaluable experiences from them. Hopefully, you’d discovered both the good, the bad, and the ugly from my ventures and can decide for yourself if P2P financing is suitable for you.
If you are up for it, you may open an account with Funding Societies. You would be credited RM 30 from Funding Societies for investing RM 1,000 into any types of investments offered by Funding Societies.
Disclosure: The above is my referral link. Many had used it and thus, allowing me and you (both of us) to be credited an extra RM 30 which can be used for investments in Funding Societies.