(Christy Bieber)
If you don’t have a lot of money but want to start investing, it can be tempting to look for low-priced stocks. This could even include penny stocks, which typically cost less than $5 per share.
Unfortunately, while these stocks might seem like an ideal way to gain equity exposure when you have limited cash, you’re taking a huge, unnecessary risk when you focus on finding companies with the lowest price per share. .
The good news is that you don’t have to choose low cost investments even if you only have a few dollars to spend, because now there is a better solution.
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Why cheap stocks can be a bad investment
There are a few big problems associated with buying cheap stocks just because you have a small investment budget:
- Most of the lowest priced stocks are penny stocks. These are not very well regulated, they tend to provide much less information to potential investors, they have a low trading volume and therefore can be difficult to buy and sell, and they can be more vulnerable to scams .
- A low price does not necessarily translate into good value. A stock may be “cheap” in terms of a low price, but it may not even be worth the money you would pay if the company has serious problems or little future potential.
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In other words, there are plenty of situations where you get what you pay for – or less – if you’re looking for a good deal and using a low price per share as your primary criteria for finding it.
What should you buy instead?
The good news is that a low budget doesn’t mean you’re relegated to buying stocks with a low price per share. You can buy almost any stocks you want, even ones that cost hundreds or thousands of dollars per share – even if you only have $5 or $10.
This is now possible because most brokerage firms offer fractional shares. Fractional shares are simply parts of shares, such as 1/20th of a share or 1/100th of a share. Typically, brokerage firms allow you to buy them by specifying the amount to invest in a particular company or fund. If you have $10 and want to buy a stock that is priced at $100, you will end up with 1/10th of a share.
So why would you want to buy such a small percentage of a stock instead of going for cheap stocks? Because no matter how much or how much of a business you own, you always get the same percentage gain if your investment performs well. Whether you buy 1/10th of a share, 1,000 shares, or 1 million shares, if the stock price goes up 10%, you end up with 10% more money than you started with.
Since fractional shares mean that you can now buy shares of any company you want, regardless of the size of your portfolio, you are not deprived of the opportunity to invest in companies that you think will work well over time. You have a much better chance of growing your wealth this way than if you used your $10 to buy a stock with a price of $1 that no one had ever heard of and had nothing to recommend other than its low entry cost.
Different brokerage firms have different rules when it comes to fractional shares, with some allowing you to invest as little as a penny in a stock and others limiting you to trades with a minimum of $5. Just find one with features you like that offers fractional stock trading, and you’re good to go.
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