Should I be taking more risk with my money?
That’s the question millions of people with savings could be asking themselves at the moment thanks to the ongoing record-low returns on bank deposit accounts.
The latest research from analyst Moneyfacts.co.uk says that the average return on a standard instant-access savings account was just 0.67% in May. For those willing to tie their cash up for a year or more, the typical annual interest rate is only fractionally better at 0.79%.
Inflation may be hovering around 0% at the moment but these are nonetheless desultory returns by anyone’s standards.
So how can you give your rainy-day cash a significantly better chance to grow?
The answer lies in taking more risk. In the past, those with money to spare could increase their potential returns by putting it into the stock market. With shares and investment funds there is the chance that your holdings will lose value but generally in the past, returns on long-term equity holdings have been positive and outperformed cash.
But the good news for those of us who don’t want to dabble in the markets is that there is now a third option. Peer-to-peer (P2P) lending which Zopa created back in 2005 involves less risk than stocks and shares but offers significantly higher returns than the typical savings account.
P2P platforms give individuals the chance to lend their spare cash to other people directly. But by cutting out the middleman – i.e. high-street banks – both parties get a better deal: lenders in the form of higher returns on their money, and borrowers in the form of cheaper loan rates.
With Zopa, for example, lenders can expect projected returns of 5% a year if they choose to relend funds over four to five years, or 4% for lending over two or three years although rates can go up or down and are not guaranteed.These figures dwarf the average yields cited by Moneyfacts above.
So what risks are P2P lenders taking to achieve these returns?
Well, for a start there is no government-backed guarantee of money lent through P2P platforms as there is with bank deposits. Under the Financial Services Compensation Scheme, the first £85,000 of each customer’s cash is protected in the event of a bank going bust.
But P2P platforms do have their own protections in place to minimise the risk that borrowers will become unable to repay their loans.
In the first instance, the likes of Zopa only lend to the most creditworthy super prime and prime borrowers meaning around 80% of applications are declined. Next Zopa spreads each lender’s cash among a large number of borrowers: this diversification reduces the potential impact of any individual being unable to meet their repayments. The projected returns also include some provision for expected defaults.
As an extra backstop, Zopa also has a Safeguard Fund to cover the cost of any future defaults. At present the amount of money in this fund is more than £8 million, and while this is not a guarantee or a type of insurance product, this helps to give Zopa customers extra peace of mind.
So the deal with P2P lending is clear: in exchange for taking on the extra risk we have just described, anyone can achieve returns several times higher than are currently available from the banks meaning you can compound your returns and interest over time to make your money work harder and increase your future wealth.
Is it any wonder that the amount of money being made available through P2P platforms has hit record highs this year?
Find out more about how to boost your returns by lending through Zopa.
With P2P lending your capital is at risk. More details can be found in our risk statement.