Private credit can add income to a large, diversified portfolio, but it behaves like risky credit in downturns and is illiquid, so it should be sized small and spread widely.
8 min read · Level 3
The most expensive idea in retail credit is that income is the same as safety. I think an investor who remembers that private lending is a bet on borrowers staying solvent through bad times will size it sensibly, and one who thinks of it as a better savings account will learn the difference during the next recession.
Where private credit fits depends on what it replaces. It is often marketed as a better-paying alternative to bonds. Economically, most retail private credit is closer to high-yield or unsecured credit: its value falls when the economy weakens, just as equities do.
Role in a portfolio Government / investment grade bonds Retail private credit Stability in stock falls often holds up or rises often falls with credit conditions Liquidity high low Income lower higher
So private credit usually belongs in the part of a portfolio that takes economic risk, alongside equities and high-yield bonds - not in the defensive part meant to cushion falls.
For individuals who choose it, three principles help:
Size small enough to be locked up for years without harm Spread many loans, several platforms or a diversified fund Prefer senior, secured, well-covered loans over higher headline rates
Because swapping safe bonds for private credit changes a portfolio's behaviour in a crash. The defensive part that was meant to steady things becomes another source of loss and illiquidity.
It also stops the common error of chasing yield. Adding more lending to reach a target income increases risk more than the extra interest suggests.
This is educational information, not investment, securities or financial advice. Rules differ by country and change — get advice from a qualified professional in your jurisdiction before acting.
Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.
Sources: U.S. SEC - Investor.gov, asset allocation; UK FCA - information for consumers; FINRA - investor information
A portfolio before and after. An investor with 60% equities and 40% government bonds replaces half the bonds with private credit to raise income.
Before: 60% equities, 40% government bonds After: 60% equities, 20% government bonds, 20% private credit
In a recession, equities fall. Previously the 40% in government bonds would have tended to hold value and could be sold to rebalance. Now half of that defensive allocation may be falling too, and cannot be sold. The investor has more income in normal years and a portfolio that behaves more like 80% risk assets in bad ones.
Placing private credit in the defensive part of a portfolio because it pays interest. Income does not make an asset defensive; how it behaves in a downturn does.
Count private credit with equities and high-yield bonds when judging how much risk your portfolio takes.
Retain enough high-quality liquid bonds or cash to cushion market falls and fund rebalancing.
Spread across many borrowers and intermediaries, and prefer senior secured positions with strong cover.
When you already have a diversified portfolio with adequate defensive assets and want some additional income from capital you can lock up.
When it would replace your defensive assets, when you need liquidity, or when you are chasing a target income. Many investors do well with none.
During long periods of very low interest rates, regulators including the UK FCA and U.S. SEC issued warnings about retail investors moving savings into higher-yielding but riskier products, including mini-bonds and lending platforms, often described in marketing as safe or secure. Several such products later failed.
When safe assets pay little, riskier income products look most attractive and are most likely to be misunderstood.
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