With employee W-2s in the mail and your accountant chasing old expense receipts, tax season for business owners is well and truly here. The start of tax time also serves as an important reminder for entrepreneurs to contribute to their retirement nest egg.
For business owners, it can be tempting to throw every penny you earn back into the business -- especially in the current low-rate environment -- but investing in retirement today is crucial for a business owner and their business’s long-term financial security.
For entrepreneurs seeking yield and diversification opportunities for their individual retirement accounts (IRAs), a growing trend in investing to consider is peer-to-peer (P2P) or marketplace lending. Marketplace lenders are online, nonbank platforms that match people or businesses looking to borrow with investors who want to lend. These platforms offer individuals a compelling new way to invest: direct access to high quality consumer, small business and other types of loans.
Some platforms offer the opportunity to access double digit net returns, compared with lower yields from U.S. Treasury notes or other traditional fixed-rate term products. Along with attractive yields and consistent returns, investors can also feel good about the fact that they're directly helping great small businesses, students and other people in the community access fair and transparent financing. For entrepreneurs, there are also tax benefits of holding P2P loans in an individual retirement account.
Many major marketplace lenders, including my company Funding Circle, that exclusively focus on secured small business term loans, welcome investments via traditional and Roth IRAs. For individuals whose current retirement account cannot accommodate P2P loans, consider opening a self-directed IRA so that you can access tax-free or tax-deferred income.
Here, my top tips for entrepreneurs considering investing in P2P loans as part of their retirement plan:
1. Find a platform you trust.
Given investors’ appetites for yield in the current low-rate environment, there are a lot of new entrants into the P2P lending market, so it’s important to put your money to work with a well-established and respected platform. Look for a platform that is well-capitalized, has clear and transparent underwriting procedures, experience and proper infrastructure around servicing and a track record of predictable returns. Lend Academy can be a great resource for researching potential platforms and offers some great advice on P2P lending best practices. Due to tight regulations, some platforms only cater to accredited investors. Visit the SEC’s website to check if you qualify as an accredited investor.
2. Manage risk through diversification
It’s important to remember that some borrowers will not be able to repay their loan. Credit risk is somewhat idiosyncratic, so building a diversified pool of loans is probably the safest way to make money in this new category. On a granular level, this simply means lending across a number of businesses (or consumers needing money), so you are only lending a small amount to each one. To do this, look for a platform that offers the opportunity to purchase fractional pieces of loans, as opposed to whole loans. Entrepreneurs with a sizeable amount of investable capital to invest could even consider lending across multiple platforms. From small business and student loans to consumer credit card refinancing, a number of different P2P lenders have popped up specializing in different forms of secured and unsecured financing. For example, Funding Circle offers qualified individuals the opportunity to invest in fractional pieces of secured term small business loans.
3. Set it and forget it.
Save hours of trawling through hundreds of loans every week by only working with platforms that offer an auto-bid function. Based on your investment goals and risk tolerance, simply set your investment criteria -- preferred risk level, rate, term, industry sector or region -- and then automate your investing. Many of the bigger platforms offer API functionality, so savvy investors can build their own programs to quickly and automatically analyze, purchase and track investments.
4. Don’t let returns sit idle.
As principal and interest payments trickle in from your investments, ensure these returns are automatically lent back out to new borrowers, so you can spread your money across even more loans and further diversify your portfolio. The last thing you want is cash sitting idle in your account, earning no interest and bringing down your overall return.
As always, every business owner’s investment objectives are different, so speak with a financial advisor if you have any questions on which investment products will best balance your risk tolerance and appetite for yield as you build your retirement nest egg.