Don’t invest in a person or a company on the basis of its name and fame
The rise of crowdfunding and its offshoots have attracted big names. Celebrity artists like Neil Gaiman and Whoopi Goldberg have utilized crowdfunding campaigns. Businesses more familiar to our ears have tapped into peer-to-peer (P2P) financing. How exciting to invest in their projects!
Careful though! You know the saying: “if something is too good to be true… it usually is.” A famous person or big company can create awe and a false sense of security. We can automatically assume they are genuine and more investible. But be cautious. Crowdfunding and P2P financing are generally utilized by up-and-coming artists, growing startups, and SMEs. Of course, well-known establishments can choose to raise funds from crowdfunding or P2P financing, usually because crowdfunding provides a faster process compared to conventional channels such as banks.
How do we tell if these crowdfunding opportunities are the real deal? Treat famous names like any other investment. Objectively and rigorously. Ask the important questions: does this well-known figure have financial problems? How is this company doing according to its financial statements? Growing? Healthy? Well-run and profitable?
Do your research
Related to advice number 1, avoid fraud by asking for fact sheets and reviewing them. A crowdfunding or P2P financing platform should have performed their own assessment, but protect your funds by doing your homework.
You are allowed to ask for the crowdfunded entity’s financial statements if you are investing in it. In fact, be wary if you can’t access financial information easily.
It’s crucial to learn how to read financial documents. Learn which accounting elements show business health. Learn which accounting elements display promising business growth.
Do diversify your investments
Our third advice relates more to P2P financing investors than crowdfunding donors. Crowdfunding backers tend to donate funds out of altruism or for intangible rewards. However, if you are crowdfunding as an alternative investment, diversifying your funds/investments is a must do!
What is diversification? It simply means distributing your money across as many investments as possible to prevent loss in case of default.
No matter how thorough our due diligence, risk is an inevitable element of any investment. Diversification is the answer to such risks. For example, if you pour RM 1,000 in only one company and it defaults, your returns will drastically drop. You’ll probably lose money. Yet when you spread your funds to two, five, even ten businesses, your returns will remain positive and will stay close to the expected rate of return.
It’s important to repeat: diversification keeps your rate of return steady, even in the case of defaults.
Do reinvest your returns
Our final advice also pertains more for investors building a portfolio. If you want to maximize your venture into P2P financing, you need to start reinvesting.
What we mean by reinvesting is using your gains to fund other businesses. Reinvesting multiplies your returns. Now, who doesn’t want to double and triple their money?
Without reinvestment, you simply receive gains according to a loan’s expected rate of return. Here’s an example: You invest RM 1,000 in a business that offers an annual 20% rate of return. The business succeeds. You earn returns of RM 200 in a year.
Let’s see what happens when you reinvest. You invest RM 1,000 in a similar business that offers a 20% rate of return. After month 1, you earn a return of RM 16.70 (from annual gain of RM 200 divided by 12 months). Immediately, at the start of month 2, you reinvest the money into a similar loan. At the start of month 3, you reinvest your earnings from month 2 into yet another loan. And so it goes until the end of the year, when it is very likely you have doubled your investment instead of only gaining a profit of 20%.
Reinvestment requires minimum effort and is a great form of passive income. All the more reason it is a definite do!
Should you be interested in learning more about the many benefits of investing in P2P financing, click here.