Probably one of the biggest deterrents to learning about investing is that the learning curve is extremely steep for the beginning investor. There are so many different types of investments, so many different industries, so many types of analyses and calculations. Many people take one look at this situation, feel so completely helpless and overwhelmed and just give up. They don’t open their 401(k) statement or read a prospectus or even borrow a book from the library. They just hope for the best, do a little here and there, and take comfort knowing that safety nets like Social Security are out there to help.
Unfortunately, the reality for most of us is that we can’t rely on this ostrich-like strategy any more. We have to know what we are doing, even if that means confronting a lot of bad news or having to change.
If we want an example of this, Americans can look to our own federal government. We all know that for many, many, many years, the government’s finances have been a mess. But how many of us have any idea how bad they are or exactly what it will take to fix the situation?
I didn’t feel like I really understood any of this discussion—except in the broadest of terms. So, I recalled another investing mindset rule that has served me well:
Restate a complex investing scenario into something you do understand.
In the next couple of posts, we will organize information on the U.S. government’s finances in a couple of different ways. It is my hope that this information will help us all to become better investors of our own money and also better stewards of the nation’s finances as well.
|First of all, how do we even begin looking at the government’s finances? Fortunately, for us, this is already someone else’s job. Whose job? Gene L. Dodaro, Comptroller General of the United States. Mr. Dodaro’s biography indicates he has a bachelor’s degree in accounting as well as 30 years of experience at the Government Accounting Office. Mr. Dodaro is accompanied in this work by Robert F. Dacey, Chief Accountant, who is an accountant and lawyer and a recognized authority in accounting circles.|
Last year, Mr. Dodaro and Mr. Dacey were involved in producing a document called Fiscal Year 2011 Financial Report of the United States Government, which is in many ways similar to a 10-K issued by a publicly traded corporation.
Auditing the finances of the federal government is a completely daunting task because of the sheer size of the government. Where to begin? First, they narrow down “the government” to a list of 35 of the most important agencies.
The 35 Government Agencies Included in the U.S. Government’s Fiscal Year Report
While this is a huge list, I am sure there are probably other agencies not listed here. For whatever reason, those other agencies are not included in the fiscal year report.
After they go through the books of all these agencies, they produce the fiscal year report letting us know how the government spent its money. For the past several years, these financial results have been terrible, reflecting huge deficits.
The U.S. government’s finances are in the trillions of dollars. The concept of a trillion is just too much for most of us to grasp. For example, I could tell you this true but brief summary of the government’s 2011 financial picture:
2011 U.S. Government Financial Summary
Income: $2.4 trillion
Expenses: $3.7 trillion
Deficit: $1.3 trillion
Since my own finances do not involve trillions of dollars, I don’t really know how to process this information. But when I took these same numbers and scaled them down proportionately to reflect a middle class family’s income, they looked like this:
2011 U.S. Government Financial Summary Scaled Down to a Middle Class Family’s Income
Now, the situation still looks bad but it is finally relatable. Imagine for a moment that our hypothetical family had a year where they had to replace the roof on their home, had some sort of medical catastrophe and had to buy a new car. The family could easily overspend their income doing these things, and probably paid for them by taking out a home equity line of credit, car loan and credit card debt. It was a tough year for our country last year and you could say that the complex transactions conducted by the government were similar to these family challenges.
If this were an isolated incident, the government, like the family, might heave a sigh of relief that it made it through the year and then start constricting expenses to be able to afford all of our newfound debt. Unfortunately, the government has been doing this type of spending every year for a long period of time. There is always some emergency we haven’t budgeted for, some exciting new thing we want to build or buy, some expense that we wouldn’t dream of letting go. So, the government, like some families, just keeps charging and charging, tiding things over for one more year.
What does the government’s net worth look like now? Below is a chart from the most recent financial report for the government:
Again, these numbers are so astoundingly large that they defy comprehension. A net “worth” of -$15 trillion dollars? If we relate them down to something we can understand, like a house and mortgage, we get something like this:
2011 Government Assets and Liabilities Related to the Average Middle-Class Family
Assets (House): $113,000
Debt Securities and Pensions (Mortgage): $665,000
Other (Credit Card Debt/Car Loans, etc.): $63,600
Net Worth: -$615,600
As you can see, the government is incredibly leveraged. The typical family in this situation would most likely declare bankruptcy and start over. Just the $63,600 in credit card debt would be enough to push most families to the brink.
We know (hope) that bankruptcy isn’t an option for our government, so what can be done about this terrible situation? In my next post, I will talk about that in context of another investing mindset rule.
In the meantime, I ask you to think about an investment you don’t understand and try to relate it to something that you do. In my case, the investments that confuse me the most are the mutual funds in our 401(k) plans. Over the past year, I have been trying to track the investments on a quarterly basis and equate them as closely as I can to traditional stocks. I also try to simplify all the complex data into simple questions like “If I add up the beginning balance plus all contributions in this investment, is the current value of the investment more, less or the same compared to what I started with?” “Which investment made the most money? Which made the least?” “What asset category is this investment in?” I still can’t make the accounting numbers work out exactly for these mutual funds (for reasons I still don’t understand) but I feel a little more empowered to deal with these funds and at least have a framework to get started.
Have you used a relational mindset to help you make more sense of your money? Please share in the comments.