Forget P2P! I’d focus on the Stocks and Shares ISA instead

Road sign warning of a risk ahead

The recent collapse of leading peer-to-peer (P2P) platform Lendy has highlighted the inherent risks of this sector.

Peer pressure

Lendy went bust last month leaving 22,000 investor anxiously waiting to see how much of their £165m can be salvaged. P2P platform BondMason is winding down after saying it cannot offer a decent return because of rising costs, although it says no investors will lose money.

An estimated 275,000 people currently invest more than £5bn across 68 platforms, drawn by prospective returns of between 5% and 15% a year, which can be taken tax-free inside the Innovative Finance ISA. City regulator the Financial Conduct Authority (FCA) is now tightening the rules amid fears more platforms could fold.

Sinking ship

P2P has a place, if you understand what you are getting into. Platforms take your money and lend it directly to small businesses or individuals, cutting out the banks so both sides get a better return. Lendy wooed savers with 1% interest per month, or 12% a year, and bolstered its credibility by sponsoring the Cowes Week sailing regatta. Then it set about chasing high yields without doing due diligence on borrowers.

From December, new FCA rules will bar private investors from putting more than 10% of their ‘investable assets’ into P2P, unless they have taken independent financial advice.

If still tempted, do your own due diligence on any platform, and remember that P2P is not covered by the Financial Services Compensation Scheme, which covers the first £85,000 of cash savings.

High and dry

I would urge caution, though. Investments that aim to produce fixed, high income have come unstuck time and again. Remember high income precipice bonds? Absolute return funds have underperformed badly. Mini-bonds are another risky area. London Capital & Finance (LCF) collapsed in March owing £214m to 14,000 investors.

Personally, I would stick to a Stocks and Shares ISA. They’re still risky, just ask anyone who holds Woodford Equity Income. Stock markets can crash at any time, while individual companies can go out of business, with no redress. BT, Centrica, M&S, Provident Financial and Royal Mail have all plunged by more than half in the last few years.

The key difference is that people know shares are risky. It goes with the territory. You can massively spread that risk by building a balanced portfolio containing dozens of stocks, or hundreds if you buy a tracker such as an exchange traded fund (ETF). Then further protect yourself by investing for the long-term. By this I mean decades, rather than more short-termist P2P options.

Think long

Another attraction of dividends for income seekers is that you’re buying into a rising yield, whereas P2P offers a fixed return.

Still, a little P2P can’t hurt. If you go for a double-digit yielder, I’d suggest investing no more than 1% or 2% of your portfolio. You could lift that to 5% or 10% if you include more established names, such as RateSetter, the UK’s most popular platform with 80,000 investors earning on average 4.4% a year.

I still believe that most of your long-term money should go into shares, though. Mine does.

Who doesn’t want to achieve financial independence?

To never need to work again… Even if you’re like me, and you love what you do, financial independence is a goal most people would love to achieve. FREEDOM to work on whatever projects you like — or not to work at all! Download your free copy of “The Foolish Guide To Financial Independence And Retiring Early” to discover how you and your family could achieve greater financial security and a better quality of life. Click here to start now.

More reading

Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.