Investing in debt: return and risk

Debt as an asset class

Investing in unpaid debt means buying claims at a discount and earning a return when you collect them. It is a different asset class from equities or bonds: its behaviour depends more on the solvency of specific debtors and your collection management than on the stock cycle, which makes it little correlated with traditional markets.

Where the return comes from

The gain is the gap between the discounted price you pay and what you finally recover. If you buy a debt of 10,000 for 6,000 and collect 9,000, your gross gain is 3,000 minus management and collection costs. The key is buying well (with margin) and having a good recovery strategy.

Risk and return go together

The bigger the discount, the bigger the risk: the cheapest debts are cheap for a reason. There is no return without risk; the aim is for the price to compensate the risk you take on.

Types of debt to invest in

• Business debts: more public information to assess solvency.
• Personal debts: the weight falls on evidence and security.
• Debts with a judgment: already recognised, lower legal risk.
• Portfolios: blocks that average the risk and allow volume.

Diversifying is key

The golden rule is do not concentrate. A single debt can fail completely; a basket of debts spreads that risk. Start with small amounts, different debtors and sectors, and adjust as your collection experience grows. Keep capital for the recovery phase, which also has costs.

How to start

1. 1

   Define your thesis

   Amount per deal, type of debt and target return.

2. 2

   Filter and value

   Review documentation, solvency and age before bidding.

3. 3

   Bid with margin

   The price must cover risk, collection costs and your return.

4. 4

   Manage collection

   Amicable agreement, payment plan or court action as needed.

A note on tax

Gains from buying and collecting debts are taxable, and the treatment depends on your situation (individual or company) and your country. This is not tax advice: consult a professional for your specific case before operating at volume.

A step-by-step return example

Picture a documented debt of 10,000 with a solvent debtor. You buy it at a 40% discount, that is, for 6,000. After collection you recover 9,000 in a few months, with 500 in pursuit costs. Your gross result is 9,000 − 6,000 − 500 = 2,500 on an investment of 6,500. The return rests on two levers you partly control: buying with enough margin and executing collection well. If you recover nothing, you lose what you invested: that is why the purchase price must always reflect that possibility.

How to measure return without fooling yourself

Do not just look at how much you make, but over what time and at what risk. 20% in three months is not the same as 20% in three years. Annualise your results to compare deals and be honest about defaults: a portfolio's realistic return is the average of the winners and the failures, not just your best cases. Always deduct management and pursuit costs, which weigh more in debt than in other assets.

Diversify by type, amount and horizon

Diversifying is not just buying many debts but spreading risk across several axes. Combine types of debtor (companies and individuals), amounts (several small positions beat one large one) and collection horizons (some fast, some longer-running). That way, an isolated default or a delayed collection does not compromise your whole portfolio. Diversification is the simplest and most effective tool to smooth results in an asset class where some claims will, inevitably, not be collected.

Common mistakes of the beginner investor

The most common early stumbles are concentrating too much capital in one debt, overpaying by falling in love with an opportunity, underestimating the time and cost of collection, and not keeping liquidity for the recovery phase. Another classic is measuring return only by the wins and forgetting the defaults. Starting small, tracking every deal and being honest about results is the best way to learn without big frights.

Time horizon: when you will see the money

Investing in debt rarely gives immediate liquidity. Between buying and collecting, weeks or months can pass, and sometimes recovery arrives in staggered payments. Adjust your expectations and your cash to that horizon: invest money you will not need right away and judge each deal by its annualised return, not the gross figure. Thinking in realistic timeframes avoids rushed decisions when a collection takes longer than expected.

Keep reading