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1 Thing You Must Do To Protect Yourself Before Investing

It goes without saying that safety is of paramount importance when driving a car.

As such, we have fail-safe systems in cars to protect us when things go wrong. Air bags, for instance, is not something we would want to use but it’s there to limit our injuries in the unfortunate event of a crash.

Similarly, when it comes to investing, we may want to have in place our own safeguards.

Short term needs vs. long term needs

While we at The Motley Fool believe in the benefits of long-term investing, we also realise that we may not have much control on what happens in the short-term. As such, it may not be wise to rely on stocks in the short run for any of our emergency needs.

Instead, we would be better off keeping a fair sum of cash on hand for any exigencies.

Ben Inker, head of asset allocation for US-based asset management firm GMO, captured the crux of the argument for keeping emergency cash here:

“Equities cost you money at such an inconvenient time. The worst returns to equities come in recessions (bad), financial crises (very bad), depressions (very, very bad), and major wars (not good at all).

While the average return to the [US-based market indicator] S&P 500 over this period was a reassuring 6.6% real, at those times when you were most at risk of losing your job, your bank account, your house, or your life, you could rely on equities to be piling on the misery.”

Emergency cash

So, what would be a good sum for one’s emergency cash?

For that, I would refer you to Step Four of The Motley Fool’s 13 Steps to Financial Freedom. Every one of us have different financial obligations, situations, and needs. But the bottom line is to make sure that we do not need to dip into our stock holdings during market downturns for our emergency needs.

As Inker alluded to, personal emergencies can often arise at times when stocks are falling and if we have to sell at those times, it’s akin to us selling our shares at the worst possible time.

Foolish summary

The Straits Times Index (SGX: ^STI) in Singapore has experienced a near-13% peak-to-trough fall in the month of August alone.

If that sounds terrible, do note that there have been even worse downturns in the market before.  For instance, there have been two years between 1993 and 2014 in which the Straits Times Index fell by more than 50% from peak-to-trough. But these painful losses hasn’t really stopped the index from climbing steadily over the long-term.

The key here may be to separate our short-term needs from our long-term goals. If we can build our own financial safeguards by covering our short-term needs, then we may begin to invest better, keeping our focus on our long-term financial goals.

For more investing tips and tricks and to keep up to date on the latest financial and stock market news, sign up now for a FREE subscription to The Motley Fool's weekly investing newsletter, Take Stock SingaporeIt will teach you how you can grow your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn't own shares in any company mentioned.