Don't Buy Penny Stocks. Do This Instead

If you are opening a brokerage account and learning to invest, you have to figure out a strategy for what to do with your money.

Sometimes, if you don't have a ton of cash to put into your brokerage account, it may feel as if your options are limited. After all, a lot of stock shares of companies you've actually heard of sometimes trade for a lot more than $100 per share -- so how are you supposed to afford that?

If you're worried about not having a lot of money to buy stock shares, you may be tempted to start trading penny stocks. That's the name given to companies that trade for under $5 a share. In reality, though, while these may seem like the most affordable option, you pretty much always want to steer clear of them.

The good news is, there are better solutions out there. Here's why you want to stay away from penny stocks, and what you should do instead.

Why you should steer clear of penny stocks

Although penny stocks can seem affordable because of their low price, the reality is that a low per-share cost does not make a stock a good deal. You want to focus on whether a company is worth its share price and whether it's likely to go up in value.

In other words, a stock priced at $200 a share that gives you an ownership stake in a solid company and that stands a good chance of providing a positive return is a much better deal than a stock priced at $1 a share with an unproven company at high risk of bankruptcy -- even though the $1 a share is "cheaper" on paper.

Penny stocks tend to be much riskier than other stocks. Not as many people trade them and they aren't as well-regulated so there are a lot more scams. Plus, they are often shares of unproven companies, where there's a very real risk of losing your entire investment.

In other words, they simply are not worth buying for most people who want to invest in the market to take a reasonable risk and build wealth.

What should you do instead?

Instead of investing in penny stocks, there's a much better option for investors who don't have a ton of money or who are looking for a stock with a low per-share price. That option is fractional shares.

Fractional shares are partial shares. They allow you to buy a portion of a share of a stock that trades at a higher price than you might be able to afford if you had to buy a full share. For example, say you were interested in buying shares of Amazon.com, which trade at around $170 a share as of early February. If you only had $50 to invest, you could buy 50/170th of a share or about 29% of a share.

Many of the best brokerage firms for fractional shares allow you to invest with as little as $1 and don't charge commission, so making small investments makes sense. And you get the same percentage gain as all other inventors. So if Amazon's price doubled, someone with a $170 share should make 100% or $170, while you'd make $50 on your $50 investment and double your share.

Most brokerage firms that offer fractional shares have screeners that help you find which ones to buy. For example, Fidelity offers a choice of more than 7,000 stocks and ETFs that you can buy fractional shares of. Rather than buying penny stocks, start researching your options today to take full advantage of this better solution.