Navigation

Why I Don’t Invest in Penny Stocks

Penny Stock Investing

We’ve all seen the ads that promise returns of 100-1000% or claim that buying penny stocks will make you rich. My principle regarding investing ads is simple – if it sounds too good to be true, it is. While no one expects to lose money on an investment, we all need to be realistic. Unfortunately many of these ads prey on our naivety and make us think our pot of gold is just around the corner through their penny stock. There are varying definitions of what a penny stock is, but what I am focused on here are stocks not listed on any major exchange and under $1.

Information is King

Whenever I am ready to make a major purchase, I look for as much information as possible. I research, looking for what best fits my needs and then use that information to make my decision. I do not take this research lightly as I am looking to part with a large sum of cash and want to make a wise decision. I use this same mentality investing in the stock market.

I am a self-directed investor  and when considering a stock purchase I spend considerable time (probably too much if you ask my wife) amassing any information I can find. Publicly-traded companies are required to publish loads of information, so it’s easy to come by. These requirements are non-existent for companies not listed on any of the major exchanges (such as those issuing penny stocks) and thus make it more difficult to come to a well-informed decision. I like to use screeners, like throse available through brokerages like Etrade or OptionsXpress to help me make my investing decisions as they take a lot of this information and pare it down to justifiable options for me.

 

Related: If you’re looking for a new online brokerage option, then check out my Scottrade review.

 

High Risk With Little Reward

We all have varying degrees of risk aversion. I tend to be on the risk-seeking end as I am willing to give up some risk to get the possibility of reward. The problem with many penny stocks is that there is very little upside potential. Sure, if you go from a share price of $.005 to $.01 you have doubled your money, but the reverse is also true.

You Can Lose Your Shirt

In theory any stock can go to $0 at any time. That is a risk we all assume when we put our money into the stock market. However, the risk is heightened when you go into penny stocks. Many times these stocks are near bankruptcy or have some other significant issue going on. This can make it extremely difficult to control losses or even get out of your investment if the company is going belly up.

Cheap Does Not Mean Good

My Dad had a saying growing up “Look for quality, not quantity.” This saying can easily be applied to investing when making a stock purchase. Would I rather buy 100,000 shares of a stock trading at $.01, or 100 shares of a stock trading $10? I am going to take the second option every time. Just because you can buy more does not mean it’s better.

Penny Stocks Can Be Hard to Sell

An inherent risk with penny stocks is that it can be difficult to get rid of them. Sporadic and irregular trading activity can cause you to lower your selling price to detrimental levels. As an aside, this can also breed manipulation of the price by some.

If it’s Too Good to be True, Then It’s Too Good to be True

Some promoters of penny stocks claim to peddle the next Google or Microsoft. Would I love to get it on a stock like that, sure I would! But, those stocks did not start out as penny stocks; they started on a major exchange. The rule of thumb to stick to is that if it sounds too good to be true, then it’s too good to be true.

This is not meant to say that it’s impossible to find success in penny stock investing, as it has happened. The problem is that the likelihood of finding success is so minimal that it’s not worth the risk. If you do choose to invest in penny stocks, please make sure and do your homework (as you would with any investment) before putting your hard earned money into it.

What questions do you have about penny stocks?

 

Photo courtesy of: Rafael Rezende

If you enjoyed this post, please consider subscribing to the RSS feed.
The following two tabs change content below.
I'm the founder of Frugal Rules, a Dad, husband and veteran of the financial services industry. I'm passionate about helping people learn from my mistakes so that they can enjoy the freedom that comes from living frugally. If you're wanting to grow your blog, check out my blog coaching services to see how I can help you take your site to the next level.

12 Comments

  • I often operate under the premise that cheap does not mean good and this goes for investing as well. Penny stocks are just that, cheap, and therefore I don’t buy them. In fact, I think more and more people aren’t.

  • John says:

    Very true on cheap not meaning good. I operate under that premise as well. Unfortunately though, the penny stock market is thriving and well. I’ve seen many people just completely throw their money away on them with nothing in return. It’s one thing if they’re just dabbling in it, but I’ve seen people throw large sums of retirement money out the window in the hopes of striking it rich.

  • Jason @ WSL says:

    I invested in penny stocks for a few years and got burned fairly badly on a number of occasions. I wrote a post about this awhile back on a different blog/interview, but I did take $3,000 and turn it into $30,000 over the course of a few months. While the speculation of the stock was still high, they hadn’t close a deal/contract yet, so I figured ‘well, I’ll hold on a bit longer because think how much this stock could be worth WHEN they actually close a deal!’

    Needless to say they didn’t close a deal and within days my $30k went back down to $3k. :) It was miserable.
    Jason @ WSL recently posted…Our Journey Update – Net Worth, Debt, and SavingsMy Profile

    • John says:

      Thanks for sharing Jason. Too bad on the loss. :( I wish I had $1 each time for the number of people I’ve spoken to that have very similar stories. We get caught up with the possibilities of what they COULD do without considering the high risk we’re taking. Thankfully, it took just one time for me to learn from this, which sounds like is the case for you.

  • I unfortunately invested in a penny stock about a year ago. I actually haven’t even checked the price in a few months, but I know that I had lost 25% within a few months. I assumed I would lose (and still assume I will lose) it all but thought it would be fun to invest in it as a friend invested about a grand of his cash into the stock.

    I don’t think I will do it again.
    DC @ Young Adult Money recently posted…10 Ways to Make Money in the Wedding IndustryMy Profile

    • John says:

      Yea, I think often times we get into a stock like that because a friend recommends it or puts there own money into it. The loss can be tough to swallow, but it does give a valuable lesson that some investments just aren’t worth it.

  • I honestly don’t know much about penny stocks. However, I do agree with your general philosophy that if something seems to be too good to be true….then it probably is. I don’t try to make fast money very often. I doesn’t usually work.
    Holly@ClubThrifty recently posted…Our Vacation Budget: Did We Stick to It?My Profile

    • John says:

      I agree Holly that you have to be skeptical if something does seem to be too good to be true. Trying to make fast money, usually does not work…but there are many better ways than through a penny stock. Thanks for stopping by!

  • CF says:

    We don’t know enough about penny stocks to want to take a risk. We’re pretty boring with our investments actually, lol.
    CF recently posted…It’s never too lateMy Profile

  • John says:

    Boring can be good with investments. :) Some would say that my investing is pretty boring as well. As long as it brings me growth, then I guess it really doesn’t matter how exciting it is.

  • Nick Swan says:

    The problem is people want to make money without doing a lot investigation and work. I think they see the penny stocks and just think of the potential huge upside. I consider investing in penny stocks similar to gambling on the horses. If you want to do it, just do it for fun and with money you can afford to lose.

  • John says:

    I tend to have the same view of penny stocks Nick. It’s about the same as throwing some money in a penny slot. Thanks for stopping by!

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

CommentLuv badge