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As we often get questions like “how to start investing with crowdfunding“, we decided to write some of our suggestions into a blog post.
The very first step an investor should take before investing in crowdfunding is to establish clear expectations and find out what are the potential risks. Crowdfunding offers a wide variety of options to build your portfolio based on capital appreciation versus cash flow. The most common strategy is to combine capital appreciation investments with cash flow investments thus balancing the risks and earning a return on your investments.
Liquidity, risk and return on investment
General economic logic allows us to assume that investments that can be cashed in quickly (very liquid) offer a lower return than less liquid investments (your funds are tied to a project for a longer period), but the latter offer higher returns on investment to compensate for the higher risk.
One might occasional see situations where a very liquid investment offers an equal or higher interest rate than a longer-term and less liquid investment opportunity. One good example is investing in short-term consumer loans (p2p loans) where platforms may offer a guaranteed X% annualized return rate.
Crowdestate’s mortgage secured objects have offered 10% interest while unsecured projects may even offer a 20%+ return for investors.
When considering the question of how to start investing, one should always weigh up the potential returns versus the risk level of the project. An attractive return on investment might hide a great risk within it. For example, recent legislative changes have capped the maximum interest rates on short-term consumer loans in several countries. Therefore, the guaranteed X% interest rate once offered by crowdfunding platforms might become void overnight if the originator was not able to foresee, assess and manage the specific market risks.
Real estate projects have considerably lower risks, as big unforeseeable changes in legislation or on the market are quite rare.
Start methodically and practise discipline
Be realistic about your expectations on potential earnings. Long-term equity investments have offered 10 – 12% average annual returns and it is quite reasonable to expect the same range from crowdfunding. We would recommend checking out funded investment opportunities to see how projects returns vary from one capital type to another.
Define the proportion of crowdfunding investments in your total portfolio
Studies have shown that crowdfunding can act as a balancing element to equities or bonds, reducing the volatility of the portfolio considerably while keeping the high returns. For junior investors, we would suggest keeping crowdfunded investments at around 20% of the total portfolio.
Find the projects that fit
Analyze yourself: do you prefer a monthly cash flow or are you also willing to invest in projects that offer longer-term capital appreciation? Projects with capital appreciation could offer a higher return but have an investment horizon of 3 – 10 years. If your goal is to build a long-term investment portfolio, you might choose to divert a larger proportion of your funds into long-term projects and allocate a smaller proportion to short-term investment. At the same time, do not forget about short-term investments as they allow you to earn returns and fund your next long-term projects.
We hope that these thoughts have given you some inspiration on how to start investing with crowdfunding!
If you are interested in additional reading:
- Is it better to invest a large sum of money all at once, or make steady smaller investments over time?
- How to assess the risk-return ratio of an investment opportunity?
- How to assess a financial model?
- Different capital types and their meaning: secured loan, unsecured loan, mezzanine loan and equity.