How Zopa beats the stock market

Would you be wise to lend your money to strangers instead of investing in shares?

I'm going to look at how two very different investments compare.

Investing in the stock market

The first is a stock-market investment, namely an investment fund called the HSBC FTSE 100 Index Retail Accumulation Tracker.

This fund tries to match the investment gains of the largest 100 or so investments on the stock market, at low cost – it’s an index tracker fund.

Due to costs and technical matters, it has lagged the index by around 1%pa over the past ten years. (This will probably improve a little, because it lowered its costs in 2009.)

Some funds do this a bit better, at a bit lower cost, but I'm just using this fund as an example.

You might pay another half percent or more each year to wrap this fund up in a low-tax wrapper, such as a low-cost share ISA or pension. Hargreaves Lansdown will charge £24pa for such a wrapper, for example. This is the equivalent of half a percent of your pot when you have £5,000. For larger pots, it'll work out at less than half a percent.

If you invest your spare income regularly in such a fund, you're likely to do much better than most people who trade investment funds and shares – and also the majority of fund managers.

Great returns come at low cost

On average, you might grow your pot by 3% in real terms. This means it grows by inflation plus three percentage points on top. This might not sound like much, but this is a great return, turning £1,000 into around £2,500 in three decades.

(You would probably have more like £8,000 when you add on inflation, but you'd be able to buy as much with that in 30 years as you could today with £2,500, due to rising prices.)

Compare this with savings accounts. These might pay 3% too – but not 3% plus inflation! Savings accounts are generally a bad place to try and grow your wealth.

Where to find more stable returns

The trouble with the stock market is that it doesn't rise nice and steadily. It goes through some long, dark periods. It’s not for everyone.

This is where Zopa comes in.

Zopa is a peer-to-peer lending website. It helps ordinary people lend their money to other individuals via the web. The lenders get better interest rates than from a conventional savings accounts while borrowers’ pay lower interest rates than for most personal loans. Borrowers also get better terms and conditions.

You won't read many big-name “expert” investment commentators praising Zopa in the press. Most of them work for the traditional industry selling pensions and share ISAs, or in related jobs. Zopa is an unwelcome competitor.

I estimate that the average Zopa lender (or investor, you could say) who pays basic-rate income tax has made real returns of 1.9%pa since Zopa was formed in 2005, after costs and bad debt. This means the lender’s pot has grown by inflation plus 1.9 percentage points each year.

This will turn £1,000 into around £1,800 in real terms over 30 years, so almost doubling what you can buy with your money.

The average higher-rate taxpayer made just 0.6% per year plus inflation, but this is still good compared to average returns in savings accounts.

Here's how Zopa beats the stock market

Zopa returns don't match up to the stock market, but the best bit about Zopa is its consistency.

Average Zopa investors – and probably the vast majority of them – will have grown their pots every single year. Compare this with those investing in the aforementioned HSBC tracker fund, who would have lost 30% in 2008.

After inflation, basic-rate taxpayers will still have made money every year. Higher-rate payers will on average have had a few years where their wealth shrank a little after inflation. However, returns are much steadier and less likely to cause you to panic and do the wrong thing at the wrong time.

Thanks to that consistency, Zopa is a better bet than the stock market for many people. This is especially true if you’re an older person. The older you are, the less time you have to wait for the stock market to recover after a crash.

Speaking as a financial journalist and investor of 14 years – but remember I'm no financial adviser – I am completely convinced that Zopa is here to stay and that it will provide reasonable, steady, long-term returns for investors.

Its concept, professionalism and ethos recommend it to me very highly. This is despite its relatively short life so far compared to the stock market.

I'm almost as convinced about the other two big players in the peer-to-peer business, namely Ratesetter and Funding Circle. I'm just a little less convinced for now, because I haven't researched them as deeply as Zopa, and they are younger.

Where Zopa fits

Zopa fits somewhere between savings accounts and the stock market in terms of risk and reward.

I think they are most comparable to inflation-beating savings accounts (of which there are currently none available to new customers), but with slightly more risk and the potential for better – or worse gains.

I think you might consider Zopa for investing lump sums, rather than putting a lump sum in the stock market, particularly if you're investing for less than 20 years.

Lump-sum investing in the stock market is more risky than most studies reveal, but you can greatly reduce that risk by spreading the lump sum around at least eight, cheap index trackers from around the world, preferably mostly in developed and less corrupt markets, and by holding for the long term.

If peer-to-peer lending or funds like HSBC's are of interest to you, take a look at the following related articles:

Zopa, Funding Circle, RateSetter

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