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Q & A:

October, 2008

Q: Why wouldn’t people take advantage of the Plumb Plan to get their debts reduced even if they are not in financial distress?

Q: I have a question about the Plumb Plan.  Why wouldn’t people who have debt, but don’t need more credit, take advantage of this to get their debts reduced even if they are not in financial distress?

For example, suppose I have a $100,000 mortgage and no other debt and don’t need to borrow going forward.  Shouldn’t I elect to participate in the Plumb Plan.  I will get my debt reduced and pay no interest going forward.  If I ever need credit, I will just pay off my reduced debt held by the government and then borrow.

A: You’ve hit on a key point.  It’s human nature for people to act in their rational self-interest.  Trying to force them to do otherwise through a mass of bureaucratic regulations is usually an exercise in futility fraught with unintended consequences and wasted energy as people try to “game the system.”

One of the things I like about the Plumb Plan is that it aligns incentives with needs.  People who don’t really need the interest-free loan would have to sacrifice a lot to get it.  They probably use credit cards extensively and pay them off each month.  But, if they applied for the interest-free loan, they would have to quit using their credit cards.  They also probably have good credit scores that would suffer if they took advantage of the plan.  They probably don’t pay much after-tax interest as it is.  Finally, the loss of their mortgage tax deduction might mean they would no longer be able to itemize on their taxes.  It wouldn’t be in their rational self-interest to take advantage of the plan.

In contrast, people who really need the plan have probably maxed out their credit cards.  They may be even seeing their credit limits lowered, so they are not giving up much by forgoing further use of their credit cards (it is probably already not an option).  They may be paying a lot of interest that they are not able to deduct on their tax returns.  Also, participation in the Plumb Plan may actually improve their credit scores.  It will at least do less damage than a bankruptcy would do.  It would be in their rational self-interest to apply for the plan.

The plan is available to everyone.  Some people will take advantage of it who shouldn’t and some people who should be in it won’t be, but if everyone does what’s in his or her own best interest, the plan should actually work out pretty optimally.  This is much fairer and more efficient than having the government decide who qualifies and complicating everything with a myriad of regulations.

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Over the years, many people have asked me for investment advice. This section is my answer to the question, “Chip, what are you doing with your portfolio?” It details the portfolio I use to implement my investment strategy— the Plumb Performance Portfolio©

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“...an investor who proposes to ignore near-term market fluctuations needs great resources for safety and must not operate on so large a scale, if at all, with borrowed money. Finally, it is the long-term investor, he who promotes the public interest, who will in practice come in for the most criticism, wherever investment funds are managed by committee or boards or banks. For it is the essence of his behavior that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness, and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

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©2009 PlumbReport.com

The opinions as to portfolio allocation and specific investment vehicles contained herein are solely the opinions of the author and are not intended to be specific recommendations which would be suitable for every investor. The suitability of any specific investment or recommendation is dependent upon many subjective factors and characteristics of the individual investor including, but not limited to, particular investment objectives, risk tolerance, investment horizon or timeline, net worth, overall portfolio allocation and income needs. Specific investments may be suitable for some investors and yet unsuitable for others due to different needs and objectives. All readers should carefully consider their individual objectives and needs and should consult with their investment and financial advisor as to the suitability of any particular investment. The author specifically disclaims any liability or responsibility for any losses, which may result from any investment or allocation referenced herein.