Investing isn't just for wealthy people -- although the share prices of Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN) might indicate otherwise. In truth, you can build a growth-oriented investment portfolio even if you only have $10 a month to spare. Two low-dollar options are penny stocks, which have been around as long as stock markets have, and fractional shares, which are a relatively new development in the financial industry.
Penny stocks trade for less than $5 per share. Some are traded on the major stock exchanges, like the NYSE, but many are traded directly between buyers and sellers in what's called the over-the-counter (OTC) market. Fractional shares are a different thing entirely. These are portions of full stock that shares that you buy for a portion of the full stock price. In other words, if Apple's $320-plus price tag is too high for you, you could buy a fraction of it. One-quarter of an Apple share would cost you 25% of the full share price, or around $80.
Penny stocks: unregulated, illiquid
As an investor who's light on cash, you might like the idea of penny stock investing. You may have even heard of some wild penny stock success stories. The best known of these is Monster Beverage (NASDAQ:MNST), formerly known as Hansen Natural. In 1995, MNST was trading for less than $1. Today, the stock trades at around $70.
Unfortunately, the Monster Beverage story is a tiny minority in the landscape of penny stocks. In reality, most penny stocks will fail and shut down, leaving investors with nothing. There are several reasons why this happens. Some of these companies aren't even legitimate. Most have poor business plans and limited access to capital.
Before you put your money into penny stocks, you should know these three things:
- OTC penny stocks are not regulated by the SEC. Public companies report their quarterly and annual earnings, among other things, because the SEC requires it. OTC stocks are not subject to those same requirements. And because there's so little public information on these companies, analysts don't follow them. That means you have to make trading decisions based solely on what the company tells you, which could be incomplete or even inaccurate.
- Penny stocks are prone to scams. Without regulation in place, penny stock investors can make wild claims to promote the companies they own to the masses. The masses buy in and the stock price rises. At that point, the masterminds behind the scam dump their shares at an inflated price. The stock price will crash, leaving all other investors with a worthless position.
- Penny stocks are not liquid. If you need to sell your shares of Apple or Amazon, you can always find a buyer. Not so with penny stocks, particularly those that aren't exchange-traded. You can't liquidate your position until someone wants to buy that penny stock at your price. And that could be a long time, or never.
Fractional shares: the real deal, on a smaller scale
As with penny stocks, fractional shares can be purchased with a low-dollar budget. If you have a brokerage account with Fidelity, you can buy NYSE and NASDAQ stocks and some ETFs, in increments as low as .001 shares at a time. On a $10 position, that's a $0.01 stock purchase. Or, with the new Schwab (NYSE:SCHW) feature recently released, you can invest as little as $5 per company. Schwab's offering will give you your pick of 10 top U.S. companies, including Alphabet (NASDAQ:GOOG), McDonald's (NYSE:MCD), and Target (NYSE:TGT).
Where fractional shares differ from penny stocks is in quality. You don't have to buy into an unregulated, unproven business model. You have your choice of the same established companies that are followed by analysts and owned by institutional investors. Outside of the price point and the unit of ownership, there are really only a few differences between fractional investing and traditional investing:
- Fractional investing isn't yet widely available. Fidelity and Schwab both offer the service. You can also buy fractional shares via several investing apps like Robinhood, M1 Finance, and Betterment.
- You can't participate in proxy voting for your fractional shares.
- If you want to switch brokerages, you may have to liquidate your fractional shares first.
Beyond those inconveniences, fractional investing carries the same risks and rewards as traditional investing.
Fractional shares are safer
At the end of the day, fractional share investing is the safer choice for small-dollar equity buys. You can start with $50 to build a diversified portfolio of high-quality, reputable companies that you can follow in financial media, and then dedicate $10 monthly to increase your positions. That sure beats throwing even $5 at an unregulated operation that could fold up and disappear tomorrow.