The Best and Worst Advice We’ve Ever Heard about Crowdfunding

Don’t
invest in a person or a company on the basis of its name and fame

 

The rise and rise of crowdfunding and its
offshoots has attracted big names. Celebrity artists like Neil Gaiman and
Whoopi Goldberg have utilized Kickstarter campaigns. Businesses more familiar
to our ears have begun to utilize peer-to-peer lending to borrow money. 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 a famous
company creates a sense of awe. Thus we automatically assume they are more
investible. Yet celebrity and fame may be shiny veneers masking some rot
underneath.

Normally, crowdfunding is a refuge for
unknown artists, start-ups, and SMEs, not establishments that can borrow from
banks. Ask the important questions: is this famous figure close to bankruptcy
and has exhausted other loan sources? How is this company doing according to
its financial statements? Is it growing? Healthy? Well-run and profitable?

It sounds as though we are making light of our
own field. We’re not. We’re just being objective. To us, a fishy loan is a bad
loan.

 

Do your research

This is related to advice number 1. Due diligence
is vital. Avoid fraud by asking for and reviewing factsheets. A crowdfunding or
P2P lending platform should have performed their own thorough research, but if
you want to protect yourself – do your homework!

This seems obvious, but you’d be surprised
by how often investors and backers dismiss due diligence. Reasons vary. Some
investors and donors are ordinary people without financial expertise. Some
crowdfunded projects are so small that they lack sophisticated statements. Even
so, you are allowed to ask for the crowdfunded entity’s financial accounts if
you are investing in it.

It is crucial to learn how to read
financial documents. Learn what accounting elements show the health of a
particular company. Learn what accounting elements display the growth of a
business entity.

Due diligence takes time and is neither fun
nor sexy. But is it necessary? A thousand times yes.

 

Do
diversify your loans

Our third advice relates more to P2P lending
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 loans is a must do!

What is diversification? It simply means
distributing your money across as many loans as possible to prevent loss in the
case of a bad loan.

No matter how thorough our due diligence,
risk is an inevitable element of any investment. Diversification is the answer
for such risks. For example, if you pour S$1000 in only one company and it
defaults, your returns will drastically drop. You will 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
crowdfunding, you need to start reinvesting.

What we mean by reinvesting is using your
gains to fund other P2P lending projects. 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 S$1000 in a business that offers an annual 20% rate of return. The
business succeeds. You earn returns of S$200 in a year.

Let’s see what happens when you reinvest.
You invest S$1000 in a similar business that offers a 20% rate of return. After
month 1, you earn a return of S$16.70 (from annual gain of S$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 gaining a profit of
mere 20%.

Reinvestment requires minimum effort and
it’s a great form of passive income. All the more reason it is a definite do!