Mate, that's not risk tolerance, that's serious naivety.
Yep, thought so. I looked in your blog and it contains the following howler:-
"
For example, if a 2008-style market meltdown occurs, I would consider shifting some funds away from P2P (where defaults would likely rise) and into low-cost, globally diversified, passive stock market index trackers which would be attractively priced in those circumstances."
I agree that this plan likely wouldn't work for
Sterling @ p2p-millionaire.com based on his published investments, since in an adverse scenario, the loans will be impaired quickly and leave him with either defaults (including originator defaults for loans with BBG) or having to sell at a discount (and unloading a portfolio that large on the secondary market would pose its own challenges). However I think that is a completely feasible, if still risky, plan for someone holding loans picked from the short end of the duration spectrum. As an example, see my portfolio below.
I also considered the short term loan only strategy, but decided I would rather diversify my holdings with more originators, rather than concentrate them in so few. And perhaps it's just my thinking, but it seems to me that the majority of the originators offering short term loans are small companies that are currently loss making. I can't qualify that with data as I have-not researched it thoroughly, but that is my impression - feel free to refute or confirm it if you have done the research.
The P2P Million Euro+ Portfolio was launched in October 2018. The alternative asset class I also hold is a typical Boglehead 3 fund portfolio - just buy and hold (I am in my early 30s so I have plenty of time to wait out any volatility). In the end, I decided I would follow a hybrid strategy which would allow a reasonable level of return (currently running at 12% p.a.) whilst waiting for a further buy in opportunity for global equities (google "mean reversion financial theory")
If you look at the 2008-9 stock market crash, it didn't crash overnight and then start the bull market - it took months to hit the bottom, over one year by some measures. People didn't lose their jobs immediately (except at Lehman Brothers!) and it really took some time for the effects to be felt at the consumer level.
We don't have a lot of data for P2P defaults during a crisis - I think only Zopa really was developed enough to give us anything useful in terms of data, and they managed to survive the crisis (does anyone have any stats for their performance over that period?)
If we look at a similar asset class like credit card defaults and returns (sorry that this data is from the US - it was all I could find on google). We can see several things from these data:
1) Default rate peak lags the start of the recession by about 12-18 months.
2) Despite an almost 3-fold increase in defaults (from 4% at the start of the crisis in 2007 to 11% peak defaults in 2009) the level of interest charged still covered the defaults, resulting in a profit for the overall loanbooks
3) Because of point 2, credit card companies as an aggregate industry, made profit every year shown on the graph.
So how does this figure into my strategy and why is it important? Well, my strategy is to only invest in loans with an originators Buy Back Guarantee. This means that the rising level of defaults only affects me if the underlying loan originator fails. So if the loan originator performs like the credit card companies above, then should be no problem. If they perform worse, then it comes down to the companies appetite and ability to shoulder their losses.
Now of course, badly run originators can fail at any time - look at Eurocent who managed to fail without any help from a macroeconomic meltdown. This is why I diversify my portfolio so that there is no more than 5% in any one originator (target is 3-4% per originator, but currently there are some at 5% while the portfolio gets established).
But if the originator is doing ok until an economic crisis event, there is a reasonable chance that the increase in defaults, at least for a time, will be covered by the yield spread. It would take time for loan originators to fail, if they were going to.
So when the world economy tanks again, as I am sure it will, and defaults start to rise on P2P, my strategy is not to panic sell at a discount on the secondary market. But rather once the decision is made, I would let my P2P loans unwind.
I would stop the auto invest profiles and allow funds to be returned to my Mintos account. I currently have about 44% of my loans maturing within 6 months, plus any interest and capital payments due from the longer term loans. That money, perhaps 50% of the portfolio within the first 6 months, would be shifted into index funds as the money became available. At this point hopefully the stock market will still be falling, or at least bouncing around sideways at a low level, and I would be cost averaging down over this period and enjoying this lovely period of stock market mean reversion.
For the balance loans left, they will take up to 5 years to fully unwind. And during this time we will really see how P2P holds up during poor economic performance. I would still allow funds to unwind (not reinvest) and buy into the early stages of the economic recovery via equities.
My personal feeling is that there will be a high level of failure for the short term loan originators, as new funding dries up and defaults rise - they will have to take a close look at their overhead costs and reduce them as far as possible until they secure new sources of funding, cash flow will be their killer. The longer term loan originators will also see higher default rates, and a lot will depend on their overall APR charged to consumers - probably their best chance for recovery in such circumstances is to renegotiate the terms of the loan with each defaulting consumer - it would be a big task and certainly very messy!
I think the worst of it will start to hit P2P between 12 months and 18 months after the start of a recession (although no one will know when the recession truly started, except in retrospect).
As a general personal finance note, as mentioned before, if I didn't invest this money in P2P loans then I would likely add more to my simple three fund passive portfolio of stocks and bonds - Bogle style (may the legend rest in peace). And in that strategy the portfolio will also lose a big chunk during a 2008 style crash.
So which is better?
If we take on one hand, the "P2P moving into Index funds strategy" (call it the Sterling Strategy) there is a fixed income of ~12% per year while the economy is on an even keel, and then potential write downs and losses to cover during an economic meltdown, but allows the opportunity to buy into equities after a reversion to the mean event.
On the other hand we have the 3 index fund, buy and hold strategy (i.e. the Boglehead strategy). Where buying in now could result in flat returns for years if a crash was to hit soon. Long term returns for global equities is somewhere in the region of 5-7% depending on who you believe.
I personally believe the Sterling Strategy
TM will perform better in a market crash, as a reasonable level of P2P defaults will be offset by buying into a falling stock market. Mr Bogle and his followers would not approve of my market timing strategy for sure!
If you've read all the way to the here, firstly - why? I started rambling half way through! Secondly, this is all personal opinion and you are welcome to point out the flaws in my logic in a constructive way - I am very open to constructive criticism. If you think I am naive then please qualify your statement with some kind of logical argument.
Also thanks to
captainconfident and
southseacompany for the replies - if you are curious to see how my portfolio performs over time I suggest you join the mailing list on my blog. The blog has just started, but I plan on writing articles on many topics, such as the above. Hopefully we can get a good debate going about the pros and cons of these strategy ideas!
-Sterling