This article was published on 23 October 2010. Some information may be out of date.

Where did the finance company money go?

A reader is trying to get his head around his finance company loss. “I’m wondering if you would please consider writing an article on how investment companies lose their money — actually our money — and what happens to the money,” he writes.

“Somebody must have it somewhere. Why can’t they be made accountable and made to return the money? If they also have lost money to somebody else, then that person or those persons must still have it or assets that they bought with it. Why can’t these people be tracked down?”

Let’s look at a couple of typical scenarios.

If a finance company lends to a property developer, the developer puts the money into buying land, developing infrastructure and building buildings. He — it’s usually a “he” — expects to repay the money when he sells the properties at a profit. Often, he pays no interest during the loan period. That gets rolled up and added to the principal at the end.

But what if property values fall? Or the developer makes bad decisions? Or work takes longer or costs more than expected — and meanwhile the interest is compounding? The loan is not fully repaid.

The finance company or receivers will go after what they can. But often a development isn’t complete, and a half-finished failure may be sold for a fraction of the money put into it.

So what happened to the money deposited by the likes of our reader? It went to the people who sold the land, put in the infrastructure and built the buildings. The finance company, or its receivers, have no right to get that money back. Those people didn’t take on the risk of the developer going broke. The depositors did.

How about another scenario — a finance company that lends to people to buy cars, appliances, electronic goods and so on? If those people get behind on their payments, the finance company will pursue them. And if they still don’t pay, it might repossess the cars and other goods and sell them.

Trouble is, second-hand goods — like second-hand property developments — are worth much less than their purchase price.

In this case, the money deposited in the finance company went to the sellers of the cars, appliances and so on. Again, they are not the ones who took on the risk. The depositors did — whether they realised it or not.

That raises a whole other issue — how much finance company investors knew about what they were getting into. It seems many people trusted advisers who, too often, had more of an eye on the commissions they received than on the riskiness of the investments.

Therein lies another destination of some of the depositors’ money — their adviser’s pocket. When an investment goes wrong, it would be great to see advisers returning to investors the commission they received, plus interest. But don’t hold your breath.

Then there are the finance company execs who lived luxuriously on a portion of their depositors’ money. Receivers may try to recover some of this. But again, the values of bought goods will have fallen, and spending on services is not recoverable.

The moral of the story is that if you’re thinking of investing in a finance company — whether or not you use an adviser — you need to know who is running the company, what they plan to do with your money, and how risky it is. And if you use an adviser, be clear about how she or he is being rewarded for investing your money.

If you’re not sure about any of this, it’s smarter to settle for lower interest in a bank.

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Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.