Diversification means spreading money across different assets, sectors, and regions so that no single loss can sink a portfolio. It reduces unsystematic risk — the risk tied to one borrower, company, or market — but cannot remove systematic risk that affects all assets. In P2P lending, diversification means holding many small claims rather than a few large ones.
Diversification of investment implies that the investor focuses on multiple different assets to reduce the risks related to market volatility, inflation, macroeconomic conditions, and other significant issues. When the investor diversifies the risk, they can quit guessing which investment project will bring more value or will fail because the spread of the risk is across many more assets.
Diversification measures how different investments move in relation to each other, and when one project is falling, another one may grow and thus reduce the correlation since the assets in the portfolio are moving in the opposite direction. This approach to portfolio composition allows for the prevention of major losses that are connected to investment.
Overall, diversification endorses the presence of stocks and assets from different countries, industries, and projects with various risk levels. This process is done with the assumption that entirely different assets do not usually behave the same way on the market, and, therefore, the risk of capital loss and unsystematic risks are reduced.
Diversification has proven its value in the wake of the financial crisis of 2008. Later, when the COVID-19 pandemic hit the global economy, diversification was there to help the investor partially mitigate the losses caused by a drastic and sudden drop in logistics that disrupted many supply chains and therefore made many infrastructural and development projects that could attract investment frozen.
Since there are many asset classes, it is important to distinguish what strategy will be the most suitable for a particular situation. Diversification across multiple assets can come in many ways; likewise, the struggle of the nations with the financial difficulties of the financial crises of 2008 and 2019.
Diversification across asset classes helps reduce unsystematic risks since all the types behave differently in the market fluctuations. The investor can buy stocks, real estate objects, precious metals, commodities, P2P investment projects, and bonds for different market conditions. It is worth breaking down every asset and its usage in a specific market scenario to understand why it is worth the diversification.
Stocks as an asset class bring the most value in developed economies with growth-focused markets. Stocks can generate middle to high equity and decent liquidity under right market conditions, yet they bring more volatility as a result of this.
Bonds offer stability during economic downturns by providing a more stable interest and the potential to retain capital. In return, the investor usually accepts lower potential returns since bonds are mainly the means to preserve capital.
Alternative assets like commodities or precious metals or real estate objects are particularly useful for increasing variety for the savvy investors. The trade-off is higher asset volatility.
Some investors might prefer P2P lending as a means to diversify their portfolio. This tool is good for stable cash flow generation and can sometimes bring good annualized return on investment (AROI), but it is not a risk-free investment. P2P lending is an alternative to traditional finance; therefore, the investor has to carry the borrower-related risk. P2P lending is not a substitution for diversification of a portfolio between the classes; it is one of the alternatives that is a separate class by itself.
Diversification in P2P lending is an alternative class that helps the investor spread the risk. The investor may buy a certain amount of claims on a designated platform, analyzing these claims based on AROI, the risk profile (including credit risk ranking from AAA to D), geography, the industry the project is in, and many other factors. For example, a P2P investor may lower borrower default risk by spreading it across multiple claims rather than one, thus reducing the chance of total capital loss.
Diversification of a portfolio can also involve a geographic one. Geographic diversification is choosing different countries with different projects to invest in. Since economic performance of the states is uneven across the globe, spreading investment across regions can help reduce certain risks.
For example, if an investor decides to lower the risk of a sudden inflation spike, it is better to invest in a developed economy that has a relatively low inflation rate or an economy that is doing well in the current cycle while keeping its inflation around 2-3%. If the investor wants higher returns, it is better to look at the emerging markets that offer better interest rates and higher potential gains, including dividends, due to more structural and liquidity risks of the investment.
Overall, the tendency to diversify the portfolio geographically helps reduce macroeconomic risks, inflation risks, and some liquidity risks as well. Developed markets like Western Europe or the United States bring stable returns and less volatility, while emerging markets like Latin America or Southeast Asia can bring more growth at a higher risk. For instance, if an investor combines a stable US market with lower yield but more stable income and an Asian investment project, they may capture diverse market trends that will help them build a portfolio that can benefit their returns to maximum capacity.
Another diversification strategy is sectoral. Some industries provide more stable interest payments, whereas the others offer higher yields and equity. The investors who seek equity may choose technology, construction, healthcare, or consumer goods, whereas those who seek more stable investment may choose the public sector or education.
If one sector declines, another will grow and help to offset the difference. The investors may buy government bonds to lower the risk or choose to lend money to a cutting-edge technological startup in renewables or fintech and get higher equity — short-, medium-, and long-term projects will provide different outcomes in different sectors, as well as across the same industry. Asset diversification based on sectors may help mitigate credit risk and interest rate changes.
Geographic diversification in crowdlending is the way to diversify a portfolio by choosing assets from different countries. Economic performance of the states is uneven, and both liquidity and equity as well as interest rates depend on how risky the investment in a project based in some country is. If an investor decides to invest in the US, they will probably accept a generally lower equity and interest rate than in Southeast Asia or Latin America, with the trade-off being more stability and, potentially, fewer non-structural risks.
P2P lending as a tool for portfolio diversification includes breaking larger projects into smaller claims with a minimum of €50 per initial investment. Then, the projects may be diversified by using an internal risk score from AAA to D to rank the projects accordingly. Furthermore, all the diversification strategies discussed above are also available when the investor needs P2P investment diversification. The table below demonstrates the axes of diversification in P2P investment.
The axes of diversification in a P2P lending portfolio — and what each one does not protect against.
Investors may use AutoInvest to organize their diversification strategy better. As an automatic investment planning tool, it will help the investor filter the projects based on the set of given criteria (geography, credit score, industry, duration of the claim, etc.). Then, the investor may choose some of the selected projects and include them in the portfolio. AutoInvest allows the registered users to have up to 10 different strategies to help with the diversification of the portfolio in P2P investment planning.
It is worth considering one illustrative example of how diversification may help the investor in P2P investments. Supposedly, the investor owns a portfolio of €5,000. In case of holding only one claim for the total sum of €5,000, the investor risks 100% of the portfolio with one default on this claim.
In case of a diversified portfolio, the situation is different. If the investor buys 100 claims that cost €50 each (minimum possible sum for a claim on Maclear), diversifying them by country, risk profile, and sector, they would only risk €50, or 1% of their portfolio, in case one claim defaults. Furthermore, the investor may smooth the potential losses through blended AROI — since the claims would be diversified, they would have different annualized returns on investment that would help balance the losses with the claims that have demonstrated gains.
Illustrative only. Diversification reduces the impact of a single default but does not protect against market-wide losses; returns are not guaranteed.
Although diversification may help to reduce unsystematic risks and help retain capital or invest in a more careful manner, it is not risk-free. The risks that remain are:
All these risks still remain and can undermine the positive scenario in the portfolio. Diversification also has its limits because “over-diversification” can happen. If the investor purchases too many assets, they may become overlapping both in terms of their risk profile and liquidity. This would create more risk since the decrease in the interest rates for one asset may cause a chain reaction and pull another asset down, making the investor lose initial principal or interest payments. Furthermore, over-diversification complicates monitoring and, therefore, can reduce the accuracy of the judgment on the portfolio in case some extraordinary situation occurs.
No, diversification does not remove all risk. In fact, diversification may help to lower unsystematic risk, but market-related systematic risks will remain nonetheless. Diversification of a portfolio does not guarantee returns and is not a way to make a risk-free investment.
Diversification means spreading money across different assets, industries, and regions in a way that a single loss does not result in a complete loss of capital. It reduces unsystematic risks like the risk tied to the borrower, company, or market, like liquidity risk. Yet, it does not remove systematic risks that affect all the assets that are on the market. Diversification does not mean a risk-free investment.
There is no specific number that is an average value for making a portfolio diversified. Diversification may be done using different asset classes and various strategies. For example, P2P portfolio diversification can mean buying more claims for a smaller sum instead of buying one or two large claims for the total capital of the investor. However, the strategy with alternative investments like real estate or commodities may differ both in the terms and volumes of the claims.
No, diversification does not guarantee against capital losses. It helps to reduce unsystematic risks like borrower default, liquidity, and inflation but does not eliminate them. Besides, the systematic risk to all of the assets in the portfolio remains since the market is a volatile structure that cannot be completely risk-free. The investor still carries the risks related to the capital invested in a certain portfolio.
To diversify across asset classes, it is necessary to consider composing an investment portfolio out of stocks, government bonds, and alternative investments like real estate or commodities. All these are different asset classes with different risk profiles, which lowers the correlation between the assets and reduces the probability of a simultaneous capital loss. Having multiple asset types in the portfolio is a way to diversify across asset classes.
P2P lending is one of the alternative investment classes that may help to diversify a portfolio. P2P lending claims may be bought with a relatively small sum (minimum €50 for a claim on Maclear) and thus help to spread the capital across different projects with a different risk profile. This, in turn, would lower the risk of sudden and complete capital losses by offsetting the losses incurred on one project with the gains received from the other.
