Peer to peer (P2P) loans allow you to act as a bank, providing loans directly to other individuals or businesses in exchange for a return on your investment via interest payments. Investing in P2P loans, which are typically smaller than a traditional bank loan, has proven to be reliable no matter the economic climate. 

"Interest rates on P2P loans have remained durable throughout economic cycles, and can provide a significant boost to portfolio income," states a P2P industry academic research report out of the University of California, Berkeley.

A businessman handing 100 dollar bills to another person.

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As investors begin to realize the opportunities for diversification via P2P loans, many P2P companies are seeing their stocks rise. 

Helping you do the hard work

Let's face it, the average investor does not have the knowledge or resources to successfully replicate the best lending practices of a bank or financial institution. This makes it difficult for investors to successfully choose P2P investments for themselves. Investing in P2P loans requires an intimate understanding of credit ratings and financial projections. It would take a significant time investment by the average investor to learn how to successfully invest in the P2P market.

To combat this barrier to entry, P2P lending platforms have devised automated investing solutions so that investors can gain exposure to the P2P market without having to take the time to learn the intricacies of the market. With an automated lending solution, an investor sets their parameters for investment, such as minimum required credit rating, loan amount, duration, etc. The automated solution then invests a set amount of capital into loans that adhere to the parameters pre-set by the investor. 

With such a solution you don't need to take hundreds of hours to understand the intricacies of these loans. Instead, you can benefit by using a simple P2P investment strategy and the automation of a lending platform.

Liquidity problems

But there are some snags to consider when adding P2P loans to your portfolio. Come into a cash crunch and need to liquidate your P2P loans immediately? Good luck. P2P loans are some of the most illiquid assets available. This illiquidity compared to traditional investments like stocks have kept many investors on the P2P sidelines.

Recently, platforms like Lending Club (NYSE:LC) have created secondary markets on which investors can sell their loan notes as needed. Investors list their notes on the Lending Club Note Trading Platform at an asking price of their choosing. Other investors on the platform browse the available notes for sale and can select any note on the marketplace to purchase.

This has helped bring more profitability and revenue to P2P lending platforms like Lending Club, the first P2P platform to open its doors to US investors in 2005. The company reported solid Q2 earnings with an 18% rise in loan originations, which brought revenues of $174.4 million on the quarter, exceeding analysts expectations. 

All told, the Lending Club platform generated over $50 billion in originations in Q2 alone. On Lending Club, investors with a minimum of 100 notes have a median return of 4.6%. And although Lending Club's stock price is down 1.6% YTD, these recent numbers point to a solid business on the rise. 

What was once a problem has been flipped with the advent of secondary trading markets. Investors can now find the liquidity they are looking for by selling loan notes on the secondary market and liquidating their holdings before maturity. 

Profit on borrower irrationality

Since P2P loans are usually smaller than those from a bank or financial institution, this can actually be a benefit to the average investor. Studies have shown that investors are more likely to pay back loans with smaller balances, as it psychologically makes them feel better to pay-off a loan completely than pay-down a loan with a high balance. It is likely this phenomenon plays a role in driving investor returns. 

As long as investors take the time to understand the P2P market and its inner-workings, P2P loans will remain a viable investment for a diversified portfolio. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.