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Emotionally Abnormal, Statistically Normal, and Healthy Cookies | Series 7.8
Episode 825th April 2022 • Enjoy More 30s: Family Finance • Joseph P. Okaly
00:00:00 00:12:00

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If we learn about normal fluctuations ahead of time, then we'll be better prepared to cope with those inevitable market downs.

  • Goal statement: "I now better understand how much up and down is normal for investments so I'm better prepared to not freak out when it does." (01:50)
  • ...he [Dr. Markowitz] could now mathematically mix together what should produce the most return for the level of risk someone was willing to take, which is fantastic, right? (06:14)
  • So when you get to a year with this portfolio goes down 12%, you could say that is actually normal. This should happen once roughly out of every 10 to 11 years. (08:47)

Quote for the episode: "And as the time period gets shorter, that range of possible returns increases. So the range for what can happen in any one month is much more than what can happen over say a 15 year period of time." (09:19)

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Transcripts

Voiceover Audio:

Welcome to the Enjoy More 30s Family Finance

Voiceover Audio:

podcast. The only podcast dedicated to making life more

Voiceover Audio:

enjoyable for young families by hitting on the financial topics

Joseph Okaly:

Hello, and welcome once again to the next episode

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of this Raising Your Investment Mindset series. This series

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we're trying to help you reframe how you may view the scary word

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that is investments, and therefore be able to utilize

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them in a more constructive way, a better way to reach your goals

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and make life more enjoyable. That is the point of all this.

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As always, if you like what you're hearing, please make sure

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to subscribe, follow us on Apple podcasts, wherever you may

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listen. The stars, the reviews, they help us reach many, many,

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many more young families out there that are just like you.

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Last week, we discussed how you probably don't just own "the

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market". Going through how what they talk about on TV really

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only represents the 500 largest US companies, not any bonds, not

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any foreign stocks, not small companies, not real estate, all

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those things that you would have as a part of a diversified

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portfolio. So don't get too worked up either way, because

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what they say on TV is probably not what you actually have. So

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if you haven't checked out that episode yet, definitely do that

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soon.

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Today's episode is titled Emotionally Abnormal,

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Statistically Normal and Healthy Cookies, where we're going to

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cover just how much investments can go up or down over the short

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term, and still haven't be normal from a statistical point

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of view despite, you know, honestly, it feeling very

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abnormal from an emotional point of view. The goal for today's

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episode then, so the if you can say this at the end of the

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episode, then you have succeeded statement is "I now better

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understand how much up and down is normal for investments so I'm

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better prepared to not freak out when it does." Again, "I now

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better understand how much up and down is normal for

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investments so I'm better prepared to not freak out when

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it does."

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When I was on my honeymoon, one of the things I tried was scuba

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diving. I didn't go out, you know, into the ocean but the

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hotel that we stayed at had this cool trial class included where

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you could just go into the pool to see if you wanted to expand

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it to a paid excursion. I thought I would just completely

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love it. I love the ocean. I love the sea, swimming

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underwater and not needing to come up for air and seeing all

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this cool stuff that's going on down there. That seemed like it

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would be right up my alley. I quickly found out though, that

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it is not the easiest thing to do. You don't just jump right

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into it. The equipment, it's big, it's heavy. And most of

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all, when you go under the water, you can't swim like

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normal. You know, I thought that I could just like swim around

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like I was holding my breath. And then it'd be all kind of the

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same thing just with oxygen attached to me. But you don't

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get a supply of air like you do above the water. You need to

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move slowly, breathe slowly, be more intentional with your

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movements under there. I felt like I was being suffocated like

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someone was trying to kill me under the water. So as you could

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guess I did not pursue the excursion. But what I did learn

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what normal was in this case when it came to scuba diving.

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And in speaking with very experienced divers since then,

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there is a ton of training that goes into it because

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encountering difficulties or obstacles that is normal. When

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it comes to scuba diving, there is a reason scuba diving is a

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question on a life insurance application. You need to know

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what normal is and what to do under the water when there is a

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problem ahead of time, so that you're not going to panic,

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you're not going to get emotional, and you're not going

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to quickly run out of air as a result, when you almost

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inevitably come across some kind of problem in your entire scuba

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diving career.

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When it comes to investments, it is hard to learn what normal is.

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Every movement in the market makes the evening news, right?

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They provide apparent reasoning at least for why it did what it

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did. And every time it goes down, they talk about it a

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little louder, a little louder, a little longer. And it makes it

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feel you know, abnormal. So what is normal then when it comes to

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your investments? If you're using a diversified so again,

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fancy way of saying spread out statistical or mathematical

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based portfolio, you can actually use math to say what is

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normal. You know, aka what should happen the majority of

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the time. The fancy intimidating word for this is Modern

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Portfolio Theory and it was developed by a guy named Dr.

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Harry Markowitz. And he basically just said we can use

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statistics to build an investment portfolio. Stocks,

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for example, they go up more long term than bonds, but they

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also have a lot more ups and downs in the short term. So risk

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along the way. So ups and downs are volatility, that's just a

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way of saying risk. They also have a certain amount of

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correlation, which is a fancy way of saying how they move

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compared to each other. So the majority of the time when stocks

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go down, bonds, they go up.

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So like for my kids that Avery and Noah are very highly

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correlated, anything that he does know within also wants to

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do, there's a high degree of correlation there. They want to

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do the same thing. Whereas stocks and bonds have a negative

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correlation. When stocks go up, bonds tend to go down. He then

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broke it down into all these different segments, or what they

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call asset classes. So small companies would be a segment an

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asset class, large companies would be a segment an asset

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class, foreign companies, real estate, US bonds, foreign bonds,

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so you can go out to 20 different little segments or

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asset classes, and each one of these different boxes,

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statistically moves a little bit different. Their long term

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return is a little different. Their ups and downs in the short

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term are a little different. How they move compared to the other

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boxes is a little bit different. But with all this information,

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he could now mathematically mix together what should produce the

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most return for the level of risk someone was willing to

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take, which is fantastic, right?

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So you know how people are always trying to make healthy

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food that also tastes great, you know, new, no fat, no

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preservative, no sugar, all organic cookies, which always

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tastes like garbage, of course. But they are basically trying to

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maximize the return, so in this case, the return is the

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enjoyment of eating the cookie, that pleasure is the return,

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while taking on the least amount of risk. So in this case, the

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least amount of unhealthy ingredients. We want the most

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delicious flavor with the least amount of unhealthy ingredients.

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So the same kind of thing is true here. If someone is a

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moderate risk tolerance, we want to try and get the most return

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for that level of risk that they are willing to take. So let's

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just say a portfolio that's mixed together has a 10% long

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term expected return. That's what the math says. And a risk

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number, which is called standard deviation, of 12%. Now this

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second number you may have seen on sheets before, and it's the

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number that normally gets ignored. Because you know,

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"what's standard deviation, why do I care, I want to look at the

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return." But this second piece is actually what allows us to

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determine what normal is. Normal means that in any one year, the

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range of possible returns that should happen the majority of

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the time should be anywhere from positive 22% in this example. So

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10% long term return plus the 12%, standard deviation, and

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negative 2%. So 10% positive return minus the 12% standard

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deviation. So basically, two out of every three years should fall

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within this range, meaning falling outside of this range

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once every three years is also normal. So that range is two out

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of three years, it should happen one out of three years, it does

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not happen, right? That would be normal. Now, if you extend this

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out to two standard deviations, so we do 10 plus 24, and 10

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minus 24. Now this range, which is positive 34% and negative

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14%, this is what should happen 95% of the time statistically.

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Again, this is what normal is so nine and a half out of 10 years,

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it should fall within this range.

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So when you get to a year with this portfolio goes down 12%,

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you could say that is actually normal. This should happen once

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roughly out of every 10 to 11 years. Now do you want your

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account to go down 12%? Of course not. Nobody wants that.

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But if we look at what normal is ahead of time, then we can be

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better prepared to cope with those downs emotionally, when

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they do eventually happen. We don't want to freak out

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underwater like the scuba diver and run out of air. And as the

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time period gets shorter, that range of possible returns

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increases. So the range for what can happen in any one month is

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much more than what can happen over say a 15 year period of

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time. If we go all the way back to 1970 and we look at that

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period of time from 1970 to today, March of 2022, the

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largest single monthly decline in the market was over 21%. It

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went down over 21% in just one month. The worst 15 year period,

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though ever over that same time period was positive 3.7%.

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So circling back around to that goal statement for today, you

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could see how much how important the time element is and how

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important is to feel like I understand now what normal is.

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So that goal statement is "I now better understand how much up

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and down is normal for investments, whether that be

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short term or long term, so I'm better prepared to not freak

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out" when it does, then if you can say that you have succeeded

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in the goal for today.

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Thanks, as always, for tuning in today and join us for next

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week's episode called Advice Should Trump Fees, The 3% Study

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where we're going to review in my opinion, how advice should be

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viewed compared to the fees for that advice and what studies

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have supported in our growingly you know, fee focused society.

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Overall, if you are able to implement what we covered today,

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fantastic. You're better off than you were before. You can

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focus more on enjoying life. If you are wanting help though with

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these things, have questions you want help in clarifying all you

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have to do is head on over to our website. EnjoyMore30s.com,

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EnjoyMore30s.com. Click on that Ask Joe and you can click

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connect with me excuse me, then. You can also connect with me

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directly if it's easier through my wealth management firm New

Joseph Okaly:

Horizons Wealth Management at nhwmllc.com. Until next week,

Joseph Okaly:

thanks for joining me today and I look forward to connecting

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with you again soon.

Voiceover Audio:

The conversations on this show are

Voiceover Audio:

Joe's opinions and provided for general information purposes

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only. They do not constitute accounting, legal, tax, or other

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professional advice for your specific situation. You should

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always seek appropriate advice from a financial advisor,

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accountant, lawyer, or other professional before acting upon

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any content or information found here first. Joe is affiliated

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with New Horizons Wealth Management LLC, a branch office

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of TFS Securities, Inc., and TFS Advisory Services an SEC

Voiceover Audio:

Registered Investment Advisor Member FINRA/SIPC.

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