Investing in the stock market can be a great way to make a lot of money. But if you're not investing in the right places, you could potentially lose a lot of money too.

Penny stocks are one of the most affordable types of investments, often trading for less than $1 per share. This can make them an appealing option for investors on a tight budget, especially considering that many companies have stock prices of hundreds or thousands of dollars per share.

But penny stocks carry a substantial amount of risk, and they can wreak havoc on your finances. Fortunately, there's a much better option: fractional shares.

Young man holding hundred-dollar bills in front of his face

Image source: Getty Images.

Why penny stocks are so risky

Penny stocks are cheap for a reason. The types of companies that issue penny stocks are usually young, volatile businesses that don't have a long track record. Because these companies haven't been around very long, it can be tough to research them and determine whether they're solid investments.

In addition, because these businesses tend to be more volatile than their large corporate counterparts, their stock prices often fluctuate wildly. Penny stocks also generally have fewer buyers than higher-priced stocks, making them harder to sell.

Say, for example, you bought 100 shares of stock priced at $2 per share. You're worried the price is going to drop, so you try to sell your shares immediately. But if nobody is willing to buy at the moment, you have no choice but to hold onto the stock until you're able to sell. Because penny stock prices tend to swing high and low, the price could plummet by the time you find a buyer.

For these reasons, it's best to avoid penny stocks altogether. By investing in fractional shares instead, you can experience the bargain of penny stocks with significantly less risk.

The benefits of fractional shares

Fractional shares are just what they sound like: small slices of a single share of stock. Instead of paying hundreds or thousands of dollars for a single share, you can buy a fractional share of that same stock for as little as $1.

The best part about investing in fractional shares is that it's an affordable way to invest in some of the biggest, most successful companies out there. Say, for example, you've always wanted to invest in Amazon (AMZN 3.55%) but couldn't afford the $3,000-per-share stock price. With fractional shares, you can invest in Amazon for just a few dollars.

It's also easier to build a portfolio of strong companies while staying within your budget. You'll ideally want to invest in at least 10 to 15 different companies to diversify your portfolio. By investing in fractional shares, you can create a diverse portfolio of strong companies for less than $100.

Maximizing your investments

Although fractional shares are a smart way to invest without breaking the bank, it's still important to choose carefully when deciding which stocks to buy.

As you're investing, it's wise to take a long-term approach. Trying to get rich quickly is a dangerous move, and more often than not, you'll end up losing more than you gain. A better strategy involves investing in healthy companies that are likely to see long-term growth.

This means you'll need to do your research before you start buying stocks. Look for companies that have solid fundamentals and are experiencing consistent growth. You might not see explosive returns when investing in these types of businesses, but you're less likely to lose money over the long run.

Investing doesn't have to be expensive. Fractional shares are just as affordable as penny stocks, but they're not nearly as risky. If you're on a tight budget but still want to invest in some of the world's best companies, fractional shares are a fantastic option.