For many people who want to get into the investing game, a common first place to start is with penny stocks. And why not? Penny stocks are often very cheap, and they can lead to bigger things. The news is full of stories of penny stocks that turn you into a quick millionaire. However, penny stocks can actually be quite risky and as alluring as they may seem, you should invest with caution!

As their name suggests, penny stocks are those companies whose offerings trade for less than $1 per share. For this reason, it’s easy to understand why so many small investors get hooked on them. Trading in penny stocks can be easy, especially when there are good analysis tools such as those available at TradeZero. But are they everything they are cracked up to be, or are they all hype and sure to ruin those who spend their money on them?

That Depends

There’s an old joke told between professionals that if they don’t know the answer to a question posed by a client, just say “That depends.” That answer isn’t really an answer, but it will keep a client befuddled long enough to look up the answer. That answer is true when it comes to whether someone should invest in penny stocks. Investing in penny stocks can be a good idea, but it depends on a lot of things.

The low price of penny stocks allows investors to purchase large amounts of stocks for only small amounts of money (think owning thousands of shares). This is where the trouble starts since investors often buy more of these stocks than is wise for an unproven stock. Unfortunately, in the likely event that these stocks tank, investors lose all their money and even losing on penny stocks is still losing.

When and How Are Penny Stocks a Good Investment?

For all the gloom and doom that is forecast when many people talk about penny stocks, experts agree that under certain circumstances, penny stocks can, from time to time, be a good investment. 

First, penny stocks can be profitable if an investor knows something about the industry the stock represents. For example, California’s Silicon Valley is overflowing with high tech startups that have issued what could easily be considered penny stocks. These firms are often underfunded and undervalued. Just as is the case with many startups, the chances are excellent that many of them will go bankrupt before a year is up. Or perhaps there’s a pharmaceutical company that had some setbacks in clinical trials but ultimately they pull through. On the other hand, any of these firms could just as easily be on the upward trend of an investment tsunami and make investors rich. 

Determining the Future

Determining which firms are headed for bankruptcy and which offer potential that you will want to invest in involves a bit of guesswork and a lot of careful study. For example, back in the 1970s, Hewitt-Packard determined that GPS was not a viable commercial product, so it dumped the idea. Then, not only after the project was abandoned, a small group of HP engineers decided to attempt to develop the technology for commercial applications, a venture that many of their colleagues thought were foolhardy. Fortunately, for many drivers today, those former HP engineers and many investors who were willing to gamble on them, GPS proved to be very successful. 

Will your next penny stock pick prove to be another GPS-like miracle? It’s hard to say, but without some careful analysis and study, not to mention some great analytical software, a hunch will never be more than just that, a hunch.

Should you invest in penny stocks?

My answer for most of us young professionals reading this blog is ‘no’. However as earlier stated, the real answer is ‘it depends’. I view penny stock trading as more of gambling, which perhaps has a place in your budget. There definitely is an analytical element to them and from time to time they do really grow in value.

However, there are plenty of startups or companies that know how alluring penny stocks can be to investors and will push forward with their plans knowing they can raise easy money even if their product or plan isn’t vetted, practical or put into place.

Save 15% for retirement. Save for larger upcoming purchases and also invest in index funds. If after checking all of those boxes you want to toss a little cash into a well-researched penny stock, it could make sense for you then!

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