Some years ago, a close relative got into trading penny stocks. Relative offered to gift me a small sum of money and use that money to open an account in my name. Due to relative's previous poor financial management decisions (understatement of the year), and because relative needed my personal information to open the account, I was never comfortable with this. I managed to stall on providing the information requested until relative forgot/lost interest/moved on to other things.

Recently, the offer came up again. I am older/wiser/more assertive and have no problems straight out saying "no thank you" this time around. My refusal of the offer is mainly due to this relative's lack of past sound financial judgment and my desire to have none of my finances (even if relative is offering the initial amount as a gift) tied to relative in any way.

I also have a vague sense that penny stocks are a poor investment in general; however, I don't really know anything about them. So I was wondering if anyone here has any knowledge/experience with these. I suppose I'm just looking for confirmation that my instincts are right and that even if relative were financially responsible that penny stocks are not a sound financial investment. Thoughts?

Hi, alohabear.

I haven't looked into penny stocks in years myself. But when I did, here was what was wrong with them. A small investment can change their price much more easily than in stocks listed on the NASDAQ and NYSE. Also, they often have a higher expense ratio compared to what you are investing (this was several years ago, might have changed). Also, the data I could get on them was very limited. Although some data suggests that they might be quite profitable, the same data admits that it does not contain those companies that went bankrupt (so it is very questionable).

Personally, I would say to stay away from penny stocks. While it is true that some penny stocks have made their investors a ton of money, it is also true that they are generally seen as pretty risky. I personally would never recommend a penny stock to anyone.

I champion value investing, which provides greater profit, safety, and more predictability. My advice is to stay away from penny stocks.

Only broke people would suggest penny stocks as a way to build wealth. If you wanted to gamble, go to Vegas....it's more fun!

I have bought and not bought a few penny stocks in my day...depending on precisely how you define them. (some say less than $1 while some include all stocks less than $5 in the definition).

One I bought for about $1 in the mid 1990s. It was a biotech stock with some promising research. I think I invested about $1000 for 1000 shares. It moved decently for a few years and was up to about $4 by around 1999. Then one day a rumor broke, actually as a news story on a major source, that they had discovered a cure for a certain common cancer. The stock shot to over $100 that day - I made over $100,000 in a day. No kidding. But I held because wow, if true... The next day the company put out a statement that the report was substantially incorrect. It was based on a limited, marginal report in a scientific journal but substantially incorrect. Down to about $30...lost $70000 that day. Then slid back to about $20 over the next few weeks until I sold at $20. SO I made a bunch.

I've bought 4-5 other similar stocks over the years that all eventually went basically to zero. So maybe I am down $5k on those in total

Then there is the one I did not buy. In 2008 I was in Las Vegas. Las Vegas Sands stock was down near $2. But it was not my first trip there and I knew their hotels and casinos were as busy as ever. I decided to buy 1000 shares at $2.50 but procrastinated. It's at $52 today and has been up to $62. It's a solid company and I kick myself because the only thing that kept me from buying it was because I have sworn off penny stocks.

I'm not sure I would always avoid all penny stocks. But I would view buying them like dropping dollars in slot machines. And I would definitely do a great deal of research first. Sometimes these companies are dead, sometimes they are scams, and rarely they are just facing hard times and will pull through.

Great story DoingHomework! I think that pretty much sums up what you can expect from penny stocks. When they work out, you can make tons of money. But more often than not they do not work out.

Some risk can be lessened by thoroughly researching the companies before investing, and if you know what you're doing you can identify some real "diamonds in the rough". But it's also very important to understand that penny stocks don't act rationally. Sometimes they will move drastically on a rumor (as in your case), and sometimes they won't move at all when there is great news since not many are following them and those that do are leery.

I would never recommend a penny stock to someone unless I had first-hand experience with the company and did thorough research on their fundamentals, management and history, but even then I would still only recommend it as a speculative play.

I bought some worldcom stock just before it went bankrupt (I didn't know it would go bankrupt). Then I doubled down on its almost worthless penny stock. There was a slight uptick so I sold and ended up breaking even overall. Then they went to 0.

Penny stocks are basically gambling. They are *not* an investment. If you feel like gambling, fine, just don't pretend you're investing. Also, if you're lucky enough to see the prices rise after you buy, sell and take the gain. Don't wait until it goes back to zero.