KEY POINTS:
More finance companies are likely go under. I do not know which particular ones are most at risk, but I believe this sector is so poor there is not a finance company that I would recommend to a client or invest in myself.
I concede there are some reasonably good finance companies around, although you could count them on the fingers of one hand.
However, the ones that are fairly well- governed and managed, and which have well-diversified loan books (ie the few good ones), still do not pay enough interest over and above what I can get at the bank to attract me as an investor.
Think of it this way. If you had a 12-month deposit of $20,000 with a bank, you could get 8.5 per cent per annum interest.
With a better quality finance company your interest rate would be perhaps 9.6 per cent per annum. The difference (1.1 per cent) translates to an extra $220 a year.
When this is taxed at 33 per cent, you have earned an extra $147 by investing with a finance company instead of a bank.
Is $147 a year worth the extra risk? Not for my money.
This is not the time to take risks with the cash and fixed-interest part of your investment portfolio.
Whatever risks you might take, with volatile share markets and difficult property markets the cash and fixed-interest part of the portfolio should be safely invested. In this respect, it is difficult to beat the banks.
There is a yawning gulf between a registered bank and a finance company. When you look at a bank, you find an organisation that is registered and supervised by the Reserve Bank, and which has discipline imposed by very experienced directors. Large banks can choose top-flight directors who know they must govern for a wide group of shareholders and other stakeholders.
A finance company, on the other hand, is often a tightly held company, sometimes with little separation between governance, management and ownership. There are some very good directors of finance companies, however they are unlikely to be of the calibre of directors from major banks, nor have the governance and management systems and procedures of a major bank.
There is a proposal for the Reserve Bank to take on a supervisory role of finance companies, but probably not until 2010 - the horses will be well over the horizon before that door is shut.
None of this is to say the banks are perfect. However, in every respect they are a good deal safer than finance companies.
Finance company losses have resulted in many broken lives - investors have frequently invested retirement funds and have had their dreams turn into nightmares.
This fiasco can be blamed on three parties. First, finance companies are so often badly governed and managed with owners and directors continuing to advertise for investors' funds when they must have known they were in trouble.
Second, the financial advisers who recommended finance companies - when I look at some of their behaviour, it is only explicable by the generous commissions paid by finance companies.
Third, investors themselves have to take some responsibility for their own actions. To put life savings or money they could not afford to lose with a finance company instead of a bank on the basis that the finance company had a couple of directors who were ex-Cabinet ministers, or which was endorsed by a sportsman, does not show that much thought went into the process. To be fair to investors, many were relying on advice from financial advisers. Nevertheless, it's your money and, advice or not, you have to take some responsibility for where it goes.
I have never invested in any finance company - and would not do so at the moment. For me, the first return should always be the return of your capital - chasing "high" returns in this area simply does not work.
We may start to see some amalgamations of finance companies, which could be the saviour of some. But I am sorry to say more finance companies will go broke, with more investor pain - you can be sure of that.
* www.wealthcoaches.net
