Penny stocks are stocks that trade below $5 a share. They're much riskier investments for a number of reasons, including the fact that most companies with such cheap shares are untested and make limited public information available.
Unfortunately, they used to be the only option for investors without big pocketbooks. That's because brokers charged commissions to buy stocks and limited you to buying full shares. Things have changed now though, and big-name companies such as Tesla (NASDAQ:TSLA) and Apple (NASDAQ:AAPL) are penny stocks now. And that's not because these two innovative industry leaders recently split their stocks -- even though the splits did lower the prices.
Instead, it's because of something called fractional shares.
Here's how fractional shares have turned Tesla into a penny stock
Fractional shares are, not surprisingly, fractions of stock shares. They've existed for a while, and investors could end up with them in limited circumstances, such as when a company merged or split its stock or when an investor participated in a dividend reinvestment program. But you couldn't buy them before, as brokers simply didn't allow it.
However, a growing number of brokers now let any investor purchase fractional shares simply by specifying the dollar amount to invest. Depending on the broker, buyers may be able to buy a fraction as small as .001 of a share. With Tesla trading at around $407, that literally makes it a penny stock, since you could buy a very tiny stake in the company for as little as $0.41. And since brokers have largely eliminated commission fees, you wouldn't need extra money to buy or sell your shares, either.
Of course, not every broker has such a low minimum -- Charles Schwab (NYSE:SCHW), for example, allows fractional share trading in the form of "stock slices," but these cost at least $5. But the bottom line is that fractional shares from any broker do make buying shares of stock much more affordable.
And while you may be wondering if it's worth buying just $0.41 or $5 worth of Tesla stock, the fact is that there's no real reason not to make the purchase as long as you have a sound investment strategy and are investing in the electric car maker because you believe in its business model. You'll make the same gains, percentage-wise, as you would if you had full shares, so your money will grow if Tesla performs well. And since you can buy more partial shares any time without paying commission, you can build a larger stake over time.
There's just one word of caution to keep in mind, though: While Tesla and other companies with high share prices are less risky than penny stocks because they have a track record of performance that's convinced investors their stocks have value, no investment is risk-free. You can't assume that just because Tesla's cost per share is above $400 that the stock is worth that much or is a good buy for you. And you don't want to make any investment without a strong investment thesis, even if you're putting as little as $0.41 at stake. Tesla may well be the right stock for you, but take your time and put in the work to find out.