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New investors should do this before investing in ASX shares

preparing for changing asx share prices represented by 'be prepared' note pegged to a line
Image source: Getty Images

Before investing in ASX shares, new investors should make sure that their personal finances are in order. 

Why? Because time in the market is way more important than timing the market when it comes to creating life-changing wealth. 

The emergency fund for new investors

An emergency fund is a cash reserve that can be called upon for unexpected life events and circumstances. Ever lost your job? Been sick for an extended period? Had to buy a new car for work?

These are just a handful of examples of why an emergency fund is important. Life is complicated and messy – the exact opposite of how you want to be investing. The emergency fund will allow you to leave your ASX share portfolio alone when times get tough.

Why you don’t want to sell your ASX shares in an emergency

Emergencies are often aligned with the broader economy 

The best example of this is losing your job in a recession. 

During a recession, stock prices are naturally depressed as a result of both pessimism and poor financial performance. These are also reasons you could lose your job. So if you don’t have an emergency fund, you may need to sell your ASX shares to pay for the essentials like housing and food. In this case, you’re selling at depressed share prices. A double hit to your financial health. 

This is an even more critical point for people who receive or own shares in their employer. As ASX share investors, diversification is critical. Consider who is paying your salary when assessing your portfolio diversification.

ASX shares are a compounding machine

Looking at a chart of the S&P/ASX 200 Index (ASX: XJO), the trend is up and to the right. On average, the ASX share market provides a total return of approximately 9%. However, there are many years where the share market is up, or down more than that. 

Break it down even further and you can observe that a lot of the share market’s return is earned on a handful of extremely good days. Taking your money out of the share market, and missing out on these few days is extremely detrimental to your investing returns.

Many of you will own amazing stocks like Ltd (ASX: KGN) and Afterpay Ltd (ASX: APT). These fantastic ASX shares, like most of the market, saw a massive decline in value at the start of the year.

If you were forced to sell at the bottom of the market (on 23 March) you would’ve been selling at a discount of 21% and 77% respectively, from 20 February highs. Moreover, you’d have missed out on massive gains of 297% and 88% respectively, from the February highs (as if you had not sold).

Foolish bottom line

Over the long term high, quality ASX 200 stocks should continue to be a life-changing asset to own. However, one of the most important factors to beating the market is time.

Having your house in order before investing in the stock market will stop you from selling at the worst possible time. This maximises your chances of staying invested in stocks and reaping the rewards.

Man who said buy Kogan shares at $3.63 says buy these 3 ASX stocks now

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Lloyd Prout has no position in any of the stocks mentioned and expresses his own opinions. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of ltd. The Motley Fool Australia owns shares of AFTERPAY T FPO. The Motley Fool Australia has recommended ltd. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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