KSA عربي
KSA عربي
Global عربي
Two investors can invest in a private credit investment and both be told that they are making a 12% return on their investment. However, if they look at their real results they might find that one has made a lot more money than the other. So, what explains the difference? The question is normally resolved by how the return is measured.
When you see an advertised rate, it is telling you what you expect to earn on your investment but not necessarily what you actually earned on your capital. Your real return can be impacted by the timing of repayments, defaults, late repayments, platform fees and cash that remains uninvested.
This is particularly crucial if you are creating a portfolio instead of a single investment. For instance, Funding Souq promises investors up to 15% on the investment per year and most investments offer monthly repayments that include both principal and profit.
This means that your initial investment is continuously being returned to you and the way you spend those repayments can impact your return.
Before evaluating any P2P investment, you should be able to answer a few basic questions;
These questions are important because the profit rate that is quoted is not necessarily the same as the return on your investment.
In this guide, we will discuss in detail what is meant by yield on debt, the difference between gross yields, net yield, IRR and will work through a real-life example with monthly repayments.
We will also examine how Funding Souq reports its profit-rate structure and how investors can obtain the numbers to determine their actual profit.
At the end, you'll have a better understanding of how to get past the headline rate and how much you're really earning with your P2P investments.
The amount of return an investor actually receives in a debt investment over a certain period of time, normally in annual percentage. In simple terms, it is an answer to a question every investor is interested in, "how much is my money really earning?"
This is where yield is different from the nominal interest or profit rate. The nominal rate is the rate which is written on an investment. On the other hand, Yields looks at the return generated by the investment based on factors such as its cash flows and timing.
This difference is more apparent if the repayments are spread out over a few months. For instance, if an investment has a 12% stated rate but cash that you have waiting to be invested, platform fees or late payments and defaults can lower the return you actually receive.
That's why investors should not rely on the advertised rate when making a decision about a debt investment. The nominal rate will provide you with the quoted price of the investment whereas the yield will give you a better idea of the yield that your investment is generating.
So, after understanding that difference, it's time to decide between gross yield and net yield and determine what can diminish the yield you receive into your portfolio.
The difference between gross yield and net yield is straightforward but it can make a significant difference in your decision to make a P2P investment.
The gross yield represents the yield without deductions for losses or other expenses that lower your net return while the net yield provides a more realistic perspective of the yield remaining after the adjustments.
There are a number of factors that can diminish the return you receive from your investments;
A simple way to estimate net yield is:
Net Yield = (Total Profit − Losses − Investor Costs) ÷ Average Invested Capital ×100
Example: Suppose you invest SAR 10,000 and receive SAR 1,200 in profit during the year. If you experience SAR 100 in losses and SAR 50 in investor costs: Net Yield = (1,200 − 100 − 50) ÷ 10,000 × 100 = 10.5%
This gives you a more practical measure of what your capital produced. However, it does not fully capture when each repayment arrived. For that, investors need to look at IRR, which becomes especially useful when repayments are made monthly.
The difference between net yield and IRR becomes relevant if you are expecting to receive repayments at different times from your investment. A simple net yield might indicate your return on investment but it doesn't reflect the total amount of capital you made.
However, IRR takes one step further by taking into account the timing of each cash flow.
The concept of net yield is fairly straightforward. It analyzes the profit earned on an investment relative to the capital invested, taking into account the relevant costs or losses.
One of the drawbacks is that it simplifies the return and does not capture all of the timing of repayments. For instance, if you receive SAR 1200 over 12 months, this isn't the same as receiving the SAR 1200 at the end of the year. The earlier you receive money, the sooner it can potentially be reinvested.
The Internal Rate of Return (IRR) considers the timing and size of each cash flow. This is especially helpful for P2P investments where the investor can get his principal and profit on a monthly basis.
According to Funding Souq, they calculate the IRR based on the cash-flow profile and take into consideration the timing and magnitude of each monthly repayment. It also points out that IRR may be equivalent to or greater than the net yield, depending on the frequency of repayment.
Consider a SAR 10,000 investment with a total profit of SAR 1,200, paid together with the principal in equal monthly instalments over 12 months.
The difference is not because they make extra profit, but because they make profit at a different time. The net yield simply shows the SAR 1,200 profit against the SAR 10,000 invested. The IRR acknowledges that part of the original investment and the profit will be repaid monthly instead of being held for the whole year.
That is the main reason why it is important to compare both figures when analyzing P2P performance. Funding Souq also warns that the IRR and Net yield it shows is a forecast of a previous performance and the agreed profit rate and may vary.
For P2P investors, the way monthly repayments are used can make a difference to long-term returns. An investor can reinvest the returned principal and profit into new investments rather than taking them out as cash. This can be a source of returns that produce returns over time.
Once investors receive the monthly repayments, they normally have two options. They can take the money and spend it on themselves or invest it into something new.
By withdrawing the repayments, you'll have access to cash, but those withdrawals won't be working within the portfolio. On the other hand, reinvesting the repayments keeps the capital invested and allows future returns to build on both the original capital and previously earned returns.
According to Funding Souq, investors who are being paid monthly can either take their money out or put it back in for the highest return. The Auto Invest feature automates this reinvestment cycle so returned capital never sits idle.
To see how this can add up, consider an illustrative SAR 10,000 investment earning a constant 12% annual return, with all returns reinvested monthly.
Strategy Comparison
Withdraw returns
SAR 16,000
after 5 years
Reinvest monthly
SAR 18,167
after 5 years
Difference: SAR 2,167
This example assumes a fixed return and is not an accurate reflection of defaults, fees, taxes or time periods where money is not invested. The actual P2P returns can therefore be different.
The main point is simple: reinvesting repayments gives the money more time to generate additional returns. This is called compound growth and returns can generate returns on their own.
This difference may become more noticeable as the investor's portfolio grows over the development of several years.
If you are considering investing in a Shariah compliant P2P investment, it is equally important to look at how the returns are structured as you look at the percentage being offered.
This is because the rate does not provide any information about how the underlying financing will work or how the investor will be paid back.
According to Funding Souq, the company's investment products are Sharia-compliant and that the products are certified by Dar Al Shariah. The platform therefore adopts the term profit rate instead of calling the return on the investor's capital interest.
The difference between profit and interest comes from the way Islamic finance structures a transaction. In traditional lending, the interest is an expense that is incurred for the privilege of having borrowed money for a given time.
However, Islamic finance adopts Sharia-compliant contracts which may be established through trade, assets, leasing or other lawful economic transactions.
For instance, Murabaha financing requires the purchase and sale of an asset at an agreed profit margin while Ijara is a lease agreement in which an asset is leased in exchange for agreed payments.
These structures illustrate that Islamic finance is not just about charging interest on money but also about the underlying transaction. Funding Souq provides information on these Islamic finance structures to help explain how Shariah-compliant financing works.
This division is especially significant for investors who desire their investment returns to be sharia compliant. Rather than viewing the percentage listed on an investment opportunity, they can also take into account how the financing is organized and where the anticipated profit will be derived.
After an investor begins to compare opportunities on Funding Souq, they need to delve beneath the surface of the profit rate and grasp the numbers behind the expected return.
The platform's investment information and calculator provide figures such as the amount invested, investment period, total cash return and net yield.
After investing, the investor can focus on the actual cash flows rather than only the headline rate. The key figures to track include;
According to Funding Souq, the majority of investments generate monthly payouts of both principal and profit, and the returns that investors see are expressed after deducting applicable fees.
This allows investors to track where the real money is going back into the account and not just the original profit rate.
These comparisons can help investors gain a better understanding of how their investment is performing over time, through comparisons of the principal returned, profit received, net yield and even IRR, if available.
An attractively advertised yield may appear to be a good deal but it may not reveal the actual return for the investor. These are some common mistakes to watch for;
The main thing to keep in mind is to measure performance in terms of the return that you actually receive on your entire portfolio, not just the highest advertised return.
While a quoted profit rate can provide you with a general guideline, it may not necessarily reveal the actual profits of your P2P portfolio. The fees, defaults, late repayments and having cash that isn't invested can all affect your real return.
That's why it's important to consider both net yield and IRR to get a more comprehensive view of your performance. These two measures are different but they can give you a good idea of how much you make and when you make it.
For those investors who have been accumulating their portfolio over time, the next step is to extract value from those repayments. If you reinvest monthly principal and profit, then your returns may accumulate more returns but it depends on how well you invest and what investment opportunities you have.
One of the easiest ways to do this is to monitor your actual cash flows, compute your net yield and IRR, and reinvest repayments if it works for your strategy. This means you will be assessing the return your money really generates instead of just the headline rate.
What is yield on debt?
This yield represents the return that an investor should receive from a debt investment for a particular period of time. This return is typically referred to as an annual percentage which makes it easier to compare investments.
It is important to keep in mind that these amounts should be considered in combination with fees, repayment schedules and risk of default.
There, the actual return may be different from the quoted yield if the investment does not generate the expected return.
How do I calculate my real return on P2P investments?
This actual return begins with the income from your investments and then reduces by fees, losses and other costs.
This number should also reflect the actual time your money was invested rather than the total amount of time your capital was invested for the entire year.
These factors provide a better sense of the real profit generated from your portfolio. In this situation, the actual amount of cash received and the timing of those payments can be taken into account when calculating the return.
What is the difference between IRR and net yield?
This net yield tends to reflect the expected return on the investment after fees have been deducted and IRR also takes into account when each repayment is received.
The timing is important because if the profit and principal are paid out monthly, you can use that money to invest again. These different calculations can therefore produce different annualized figures.
In this situation, Funding Souq states that its IRR is based on the timing and size of the monthly repayment and that the IRR can be greater than the net yield if the repayments are more frequent.
How does monthly compounding affect my returns?
This monthly payment plan can enhance the return if you invest the funds received on a monthly basis. This is because the repayment of principal and profit can be invested in new ventures rather than sitting idle.
These extra investments will then provide additional returns over time. In this context, the effect will rely on how fast you reinvest and on the availability of adequate opportunity.
How does Funding Souq's profit-rate structure work?
This is a connection between the profit rate and other elements like the borrower's risk rating or the financing term.
This rate is negotiated in the finance contract and investors usually make monthly repayments that include both principal and profit. These payments enable investors to withdraw their earnings or invest them in new opportunities.
In this case, Funding Souq indicates that the returns it shows are net of any applicable fees and actual returns may differ based on the performance of the investments and market conditions.
Disclaimer:
This post is for educational purposes only, and does not constitute investment advice or a solicitation to take any financial action. It should not be relied upon when making investment or financing decisions.
