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Why I Do Not Invest In Penny Stocks

Penny stocks may look pretty and shiny at first, but it will not be much time to see them rust in front of you.

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Forge Your Wealth is meant for education and entertainment and should not be used for financial advice.

I once had a conversation with one of my former students about investments. He said he was investing in some penny stocks, told me about some recent gains he had, and asked me for advice. I asked two questions. The first question was: “I taught you chemistry, when did I become your financial adviser?” The second was: “are you investing in mutual funds?” He said yes, so that was a relief. I told him that I do not believe in penny stock investing. But after that I did some research into them. Altogether, the research did not change my mind, but it did teach me a thing or two.

What Are Penny Stocks

The SEC defines them as any stock that trades at less than $5 a share. There used to be a time where they were less than $1 a share. In other words, penny stocks can literally be bought and sold with the change in your junk drawer. There are many rules about regulating them, and if properly enforced penny stocks can be a sound investment.

The Rules Are Enforced Shakily

The key words are if properly enforced. The rules the SEC enforces towards penny stocks may sound good, but there are problems. Prices are not always available and it is not an uncommon event where the dealer cannot buy back the stocks.

The reason for this is because these stocks are not traded on the NASDAQ or any other exchange. They are traded over the counter. The paper work and trail for these stocks may be lacking at best.

What You Should Watch Out For

Since penny stocks are traded over the counter, the traders may not be well established brokers. There could be fraudulent activity in the brokerage itself.

The dealers themselves are not impartial and may want you to buy their stock more for commission than for your benefit. Let’s be honest though, that definition can fit many salespeople. Dealers are often mobile and may not stay at the brokerage firm. Whenever you trade, make sure you have copies of the paperwork to show that the trade did happen, the shares, and the price you bought it for.

But more importantly, you must know the company you are investing in. Almost every company that counts as a penny stock has less than $5 million in tangible assets. Know where the company is and what it looks like. My wife once had an interview at a company of that size. Their sign was made of construction paper. If you do not like the look of the company, do not invest in it.

Penny Stocks Are Likely To Lose Money

The SEC did research and found that most who invest in penny stocks will lose money.

Source: US Securities and Exchange Commission Division of Economic and Risk Analysis

If you want to invest, you must do so knowing that you will likely lose money. On average, penny stock investors lose around 30% each month (this is much like gambling). But why do investors try to invest in penny stocks? Penny stocks are like poorly crafted fireworks. Most will not even light, but there are few that will soar and explode radiantly. Some want to experience the beauty of seeing these fireworks.

Do Not Buy The Hype

One of the most common misconceptions I have heard is that Amazon was a penny stock at the start. Some say that if you bought $10,000 of Amazon back then you would be a multimillionaire. That is a lie, not about becoming a multimillionaire, but that it was ever a penny stock. When Amazon turned public in 1997, the debut price was $18.00/share. Most of the greatest companies were never penny stocks.

There are some companies that have or are being traded as penny stocks, at least by trading prices. These include Sirius XM, Kodak, Xerow, GM, and Pier 1 Imports. But that was not their starting price, but where they were going. This says more about where these companies ended up than whether penny stocks are good investments. That being said, it is still possible to profit from penny stocks. If it was not, no one would ever invest in them.

There Are Far Better Forms Of Investments

As Amazon alone shows, there are many companies that could provide amazing returns. These companies follow more regulations than penny stocks and are traded on established exchanges. You do not need to make such risky investments to obtain such returns. If you want riskier investments, try some small cap stocks.

Final Thoughts

I will never invest in penny stocks. I see little need to. Businesses do need to have a start, but public trading over the counter is not the only answer. Instead of trading over the counter, I instead desire to start my own business ventures. I have as much control on my investments as I desire. While there is some potential in penny stocks, there is too much you cannot control when you invest in them. If you want to be wealthy, there are far better ways to invest in them.

Author: Papa Foxtrot

Most of my life I was careful with money and learned where I should invest it. I was very lucky to have parents who taught me financial literacy when I was young. Unfortunately, I am very lucky because many people lack the financial literacy I know. The purpose of Forge Your Wealth is to teach people who are just starting out in life how to obtain their wealth or anyone who just realized they may need to learn more to handle their finances. I currently have a PhD in biochemistry, just started a job in industry (will not disclose where exactly for personal and professional reasons) and am currently married to the love of my life. I am one of the lucky few people in America who graduated with no student debts, my wife was not. Over the series of a little over 3 years we paid for our wedding with no debt and paid off her federal student loans.

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