Any blog about P2P lending as an investment talks about diversification. Many of these blogs, including great blogs from different perspectives than mine that I read regularly like Lending Memo or Nickel Steamroller advocate heavy diversification. By heavy, I mean advocating a strategy of putting very small amounts like the $25 minimum or $50 across tens or hundreds of loans. For instance, they would deploy $5000 into $25 increments into 200 loans or 100 loans of $50.
The value of this strategy is that it lowers default risk overall as the risk is spread throughout many many loans instead of in fewer loans where a default hurts portfolio performance more, which is how I do it. Another advantage is that the law of large numbers, something we have discussed before here, works in favor of this strategy as most people pay their bills most of the time. When you don't understand alot about Credit, this is a great strategy. There's one big downside though. By incorporating so many loans into your portfolio, you practically guarantee that you will get a default, even if it's for a small amount.
I don't do this strategy of putting very low amounts across many loans. If you've seen any of my Portfolio Reports, then you already know that. My whole philosophy is that understanding Credit, how it works and how people behave regarding their Credit, can allow us to get the same reduced risk of default without having to spread out over a hundred loans. It also means there is potential for greater returns if we select our loans and rates of interest that they pay wisely. The one downside is that my risk is a little more concentrated so a default will hurt me a little bit more, if it happens.
How do you do it? and why?