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Tax Refunds Are Bad (Whaaat?!) | Series 4.3
Episode 326th July 2021 • Enjoy More 30s: Family Finance • Joseph P. Okaly
00:00:00 00:11:34

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How could a big check from the government at the end of the year be a bad thing?

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Welcome to The Enjoy More 30s Family Finance

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Podcast. The only podcast dedicated to making life more

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enjoyable for young families by hitting on the financial topics

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that tend to weigh on us stress us out and distract our focus

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from simply enjoying life.

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Hello and welcome to the third episode here of the Your Major

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Money Misnomers Series. We are on the Enjoy More 30s Family

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Finance Podcast here where we're trying to help provide young

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families with information to better their lives and make it

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more enjoyable. As always, if you like what you hear, please

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make sure to subscribe or follow us on Apple podcasts or wherever

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you listen. Clicking a star leaving a review really helps us

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out helps to find other families out there that can we can

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connect with and help provide this advice to as well. Last

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week, we discussed packing for the right financial trip, and

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the three basic financial questions to help you filter out

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a lot of that advice that everybody's going to come across

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and make sure it's relevant to you, and what you should be

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working into your actual plan.

Joseph Okaly:

Today's episode is Tax Refunds Are Bad - Whaat!? -

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right, that's the initial reaction - whaat!? - but we're

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going to cover what you need to know when it comes to

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understanding what a tax refund actually means, and what you can

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do to change that amount you may be receiving, if I can convince

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you that they aren't the best thing to be receiving large

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amounts of.

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Now it's funny how your views of things seem to change. As you

Joseph Okaly:

get older, you may have experienced this too. I'm

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recording this episode right now in the heat of the New Jersey

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summer, it's like 95 degrees outside or something like that

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today. And if I was all the way back in high school, I would not

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be inside. I would be at the beach with the sole goal of

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trying to get tan. Getting some sun, getting some vitamin D,

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obviously not all a bad thing. But I can tell you right now I

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was 100% not doing it for that vitamin D. I wanted to just look

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good. So as you may think back to your early days, maybe you

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can relate with me in this. Now we've all seen kind of, you

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know, those people that live at the beach, their skin is so dark

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and wrinkled, that we really do clearly know excessive sun

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exposure - not exactly good for us or our skin! I'll go as far

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as to say intentionally exposing ourselves to radiation so our

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bodies turn tan is a little bit odd if you really want to think

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about it like that. Now we fast forward over to today. I don't

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hide under a sombrero or anything like that. But I don't

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also anymore go out of my way to try to just get as tan as

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possible. On the contrary, in a somewhat ironic twist I guess

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you could say, I instead spend my time chasing my kids around

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trying to keep them lotioned up and have hats on their heads, so

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they don't get too much sun.

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So what you need to know about tax refunds is that, like the

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summer sun, a little bit is fine, but you don't want to

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overdo it by any means. Imagine I gave you the phrase "tax

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refund", right, on a piece of paper. So imagine a piece of

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paper the word tax refund is written on it. And I said you

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have to either take this word or these two words and put them

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into a column on the left that says good, or a column on the

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right that says bad. Where do you pick yourself putting that

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phrase tax refund? You're probably going to move it over

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to that left hand column, right, into the good column. The thing

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about tax refunds is that it's someone giving you your own

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money back. Let's say someone slipped a $20 out of your wallet

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and then gave it back to you. It wouldn't exactly be something to

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you know, celebrate, right? You wouldn't feel that great about

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it. With a tax refund, no one's slipping it out of your wallet

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except for you. You're slipping it out of your own wallet and

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giving it to the government. Let's say that you make $100,000

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and you have your employer withhold 20% for taxes. So that

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is $20,000. When your accountant does your taxes at the end of

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the year, they are calculating what you actually should have

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paid in taxes for that entire year compared to what you

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actually paid. So let's say they calculate $18,000 is what you

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should have actually paid. In this example, you actually paid

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$20,000. So you receive a $2,000 refund. They gave you back that

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$2,000 of your own money. People often say things such as like,

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"I have a great accountant, they always get me a big refund".

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Assuming you have an accountant though, who's following the

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rules, they're really all just solving this math equation. And

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they should all come to the same answer really. How much did you

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pay in taxes compared to how much should you have paid in

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taxes? That's really it.

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Now you may be saying to yourself right now, you know,

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Hey, Joe, what's the big deal? So I get a large refund. Why is

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that a problem? The problem, from a financial standpoint at

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least, lies in the fact that you're giving an interest free

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loan to the government. You're saying "hey guys, here take

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$10,000 of my money. No, no, don't worry, you don't have to

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pay me anything, just give it back to me in like six to 12

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months". So that $10,000 refund every year, that's money that

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you could have had during the year invested in doing something

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for you. Let's say on average, you had that money in your

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paycheck during the year. And just for this example, say that

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you were able to invest it and earn an extra 5% that you now

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missed out on. So that might be say, $500 a year, you're missing

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out on in that example, which adds up over time.

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Taking it even further, some people that are tight from a

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cash flow perspective. So if you are a little bit tight month in

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and month out, but you get a big refund at the end of the year,

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you're really just compounding that problem. Maybe there's

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credit card debt that's building up. The less you're overpaying

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the government during the year, the higher your paycheck then is

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going to be as a result. So if you stop paying them an extra

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$1,200 a year that you're just getting back at the end of the

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year, your paycheck will now be $100 a month higher. So that can

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really help out a lot of people. And if you're having to put

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money on credit cards, and then you're just trying to pay them

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off at the end of the year with the refund, you have 15 to 20%

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probably in credit card interest that's building up, that doesn't

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have to if you just lowered your refund, your paycheck would be

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larger, and then maybe you wouldn't have to use those

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credit cards.

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The last part of this is that most people who get a big

Joseph Okaly:

refund, tend to wind up spending it - that's kind of the

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behavioral element. Even though they're giving you your own

Joseph Okaly:

money back, you're like, "wow, free money!", not "wow, I got my

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own money back!". So if you go back to Episode 2.1, Bonuses

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Aren't Free Money, it's the same kind of thing. So if I can't

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convince you to not get a big refund, I would at least

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strongly encourage you to plan ahead of time for the refund you

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get and make sure at least a portion of it is saved towards

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yourself.

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So the base adjustment you can do to fix this, so what can you

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do, is pretty straightforward. Your employer, assuming you have

Joseph Okaly:

W2 income, so salary wage income, can adjust the

Joseph Okaly:

withholding you take out for taxes. If you speak to your

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accountant, they should really be able to assist here so that

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less is taken out of your paycheck for taxes, meaning what

Joseph Okaly:

you receive is going to be greater. Again, here's an

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opportunity to save if if your paycheck increases by $200 a

Joseph Okaly:

month now let's say, that's an additional amount of money that

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can be saved towards your goals - do not just let it disappear!

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There's another option as well, that's a bit more interesting

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that might fit some people out there. If you're currently

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making Traditional 401(k) or IRA contributions, you are receiving

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a tax deduction in this process, which is contributing to the

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refund that's being received. So if you change these

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contributions now to be into a Roth 401(k), or if eligible a

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Roth IRA instead, now you will not receive a tax deduction for

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those contributions. So let's say I'm putting $100 a month

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into a 401(k) now or Traditional, and then I move it

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over to a Roth, I'm no longer going to get a tax deduction for

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that $100 a month. However, the trade off for this is that now

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that $100 a month, that's going into the Roth is going to grow

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tax free. So for some people, okay, instead of getting a

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$10,000 refund, I'm getting a $7,000 refund, you know, that's

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fine. I'm still going to now have additional tax free growth

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because I have more money going to that Roth 401(k), or that

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Roth IRA. So long term, this can very likely be more advantageous

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for your overall situation. And the trade off is just getting a

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little bit less of a refund.

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So a quick recap of today is that number one, while some

Joseph Okaly:

refund is okay, too much is definitely not recommended in my

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opinion. A refund is simply the government giving you your own

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money back that you essentially loaned them at 0% interest. Two

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is that a refund is simply an accountant calculating if you

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overpaid, or underpaid during the year. They are just solving

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this equation, they're not finding some hidden money if

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they're all following the same IRS rules. Number three, is if

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you do make some adjustments to your situation, make sure at

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least a portion of that extra money is saved. So whether

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that's, "okay, I'm getting less of a refund, so I have more in

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my paycheck, that's more I could save", or you know, "Joe, you

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can't convince me. I like my big refund, but I'll agree to at

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least say 50% of it". And then lastly changing or looking to

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potentially change some pre tax contributions, so money going to

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a Roth IRA or excuse me money going into a 401(k) or a

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Traditional IRA and moving those contributions over to a Roth to

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maximize that long term tax free savings growth.

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So that's everything I have for you today. Thanks as always for

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tuning in. If you are able to implement what we cover

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fantastic as always, that's wonderful. That's why I'm doing

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this, less to worry about then before and you could just focus

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more on enjoying life. If you are wanting help with these

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things though or have questions you need help in clarifying,

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check out that Ask Joe section on the show's website

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www.enjoymore30s.com, that's enjoymore30s.com. Again I hope

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you enjoyed this episode. If you specifically enjoyed this

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episode, make sure to follow, subscribe, review us on Apple

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podcasts or wherever you listen. There are literally millions of

Joseph Okaly:

young families out there I'm trying to reach and help just

Joseph Okaly:

like you.

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The next episode that we have coming up for you is 'Schedule

Joseph Okaly:

Goals...Achieve Goals!". Crazy right, you have to schedule them

Joseph Okaly:

first to achieve them? We're going to cover why goal setting

Joseph Okaly:

may sound very cliche, it did to me for a long time, but it makes

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all the difference in the world to achieving what would make you

Joseph Okaly:

the happiest. Until next week, thanks for joining me today, and

Joseph Okaly:

I very much look forward to connecting with you again soon.

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The conversations on this show are

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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

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registered investment advisor, member FINRA/SIPC.

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