The benefits of diversification

With this article, we would like to bring your attention to the benefits of diversification. Remember that lending to businesses comes at a risk of not receiving back a partial or even full amount lent. The best approach to minimize this risk is to invest continuously and aim to spread your investments both over time and over a number of projects. This will ensure that a) your overall return will not be affected greatly by any individual loan performance and b) you don’t fall victim to bad timing.

The benefit of diversification is clearly visible in the data of historical returns from our platform. Once we take in the effects of loan losses and provisions for loan losses, we can observe the following portfolio returns plotted against the number of loans invested by each investor: 

Chart: Portfolio return on investment depending on the number of loans invested

From this graph we can draw a number of clear conclusions:

  1. Only 3 out of 293 active investors have a negative return. All investors who have invested in 27 or more projects have a positive return;
  2. Some investors that have built a relatively small portfolio of up to 20 loans can get higher than average returns, however, most small portfolios will deliver lower than average results;
  3. Investing in all loans by Capitalia would bring a return of 10%;
  4. In many cases investors that have built portfolios with over 25 loans but have reported below average returns, have invested much higher than their average amounts in a few riskier loans;
  5. Return volatility clearly decreases with the number of loans in the portfolio.  Investing in one loan is at least twice as risky as investing in 25 loan package;

With these conclusions in mind we strongly recommend you to follow the following principles when investing in Capitalia (or anywhere else for that matter):
  • Aim to have a portfolio of at least 20-25 investments;
  • Invest a similar amount in each project;
  • Make smaller investments but invest in a larger number of projects;
  • Use our Auto-invest tool for headache free automatic diversification

For those interested in a more technical approach to the effects of diversification, we provide this chart below, which depicts the volatility of returns (standard deviation) based on the number of investments.

Chart: Volatility of returns depending on the number of loans in the portfolio
Published by at. 15:07