As you build your investment portfolio, there are plenty of assets to consider, including penny stocks.
The lure of penny stocks draws in many investors, but this high-risk investment choice isn’t the right fit for everyone. Let’s explore exactly what penny stocks are, plus, whether or not this investment option makes sense for your portfolio.
What Is A Penny Stock?
Although the name implies that a penny stock would be just a penny, that’s not often the case. Instead, the Securities and Exchange Commission (SEC) classifies penny stocks as any stock that trades for less than $4 per share.
Penny stocks are often found tied to companies with small market capitalizations. Most aren’t listed on the NASDAQ, but some are. If you want more penny stock opportunities, you’ll find them via over-the-counter (OTC) transactions. Sometimes, penny stocks are referred to as micro-cap stocks.
Penny Stocks: Advantages
Every investment opportunity comes with some pros and cons. When it comes to penny stocks, the risks typically outweigh the benefits. But there are still some advantages, including:
- Low price point: You can start investing with a minimal amount of money. With a limit on how much you put in, this could be a useful learning opportunity.
- Potential for success: Many penny stock investors lose big time. But others knock it out of the park.
Penny Stocks: Disadvantages
When assessing the opportunities in penny stocks, there are some disadvantages. A few of the big risks include:
- Risky: Penny stocks are often very risky investments that move up and down with little to no warning.
- Volatility: Penny stocks have a highly volatile price point. The low price point of penny stocks means that movement in any direction can have a big impact on your shares.
- Little information: With micro-cap companies, there’s less information available about most of the companies tied to the stocks. Additionally, there’s often very little history to look back on, with newer companies often coming into play with penny stocks.
- No minimum standards: When trading these kinds of stocks in niche marketplaces, the standards applied to regular stocks don’t apply.
In addition to the high risk, there are many scams in the penny stock industry. With that, you’ll need to be on high alert for potential scams when making a penny stock investment.
One popular scam tied to penny stocks is of the pump-and-dump variety. With a pump-and-dump scam, a scammer will buy a bunch of penny stocks and push demand for the stock by pummeling investors with false information. After the stock rises to a certain point, the scammer sells (dumps) their shares for a big payday.
Should You Invest In Penny Stocks?
It’s legitimately possible to grow your funds through penny stock investing. Tim Sykes is one investor who seems to have cracked the penny stock code. He turned $12,415 into $1.65 million in just four years.
His story shows that penny stocks can be lucrative. But it also shows how much work is involved in growing a portfolio full of penny stocks. You’ll need to be prepared to spend a substantial amount of time learning the ins and outs. Plus, be ready to monitor your stocks on a regular basis.
If you aren’t prepared to commit the time or energy required to do well with penny stocks, then it’s probably a good idea to pick a different investment strategy.
But if you are ready to give it a try, start on a small scale. Don’t invest without learning more about the process. And don’t commit any funds you can’t live without. For example, it’s usually a good idea to wait until you have an emergency fund and pay down high interest debt before jumping into investing.
Penny Stock Alternatives
When it comes to investing, you might not feel comfortable with penny stocks. And that’s okay!
However, if you were drawn to penny stocks because of its initial low minimum investment, there are more options to consider. Specifically, fractional investing allows you to start building an investment portfolio with more traditional stock assets.
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How To Invest In Penny Stocks
If penny stocks are right for you, here’s how to get started:
- Create a budget: Decide how much you are willing to invest in this volatile asset class.
- Go to a major exchange: Although you can find penny stocks on many exchanges, it’s best to stick with a reputable exchange like the NASDAQ.
- Invest in learning first: Before you buy your first penny stock, learn what makes a good penny stock investment. Don’t jump in without doing your due diligence on a particular stock.
Take things slow as you learn the best practices for your portfolio.
The Bottom Line
Penny stocks might not be the best fit for your finances unless you are prepared to carry a considerable amount of risk for short-term investment paydays. But the good news is that there are plenty of ways to build an investment portfolio.
Here are more resources from The College Investor:
Sarah Sharkey is a personal finance writer covering banking, insurance, credit cards, mortgages and student loans. She has written for numerous finance publications, including MagnifyMoney, Business Insider and ChooseFI. Her blog, Adventurous Adulting, helps young adults get a handle on their finances.
Editor: Claire Tak