Penny stocks are known for their volatile behavior. They are unpredictable, tricky buggers generally left for discussions of get rich schemes and master minds who beat the system. But this is just going to be a boring discussion about diversified accounts. The best part is for most people in the US it’s the boring who get rich.
Even in a traditional account there is room to take some risk. In fact it’s not just risk, but risk and reward. You need to compare the two. Without risk there is zero reward. In fact without any risk you may experience the not often considered risk of no action. By stuffing your money underneath the mattress you have the unintended risk of inflation eating the worth of your money. By spending every dollar you own so the money never devalues you run the risk of loss of income, as this style requires constant cash flow. There is no absolute right, it’s all a balancing game. So what does risk vs reward have to do with penny stocks? Let’s examine three fictional investor’s portfolios:
Boring Bob follows every old investment advice to a “T”. He has a 60% stock / 40% bond blend for his retirement and he sleeps well at night. How is his portfolio of $25,000 faring after 30 years? Let’s say that stocks return 8% per year and bonds return 5% per year. This portfolio would compound to about $183,000 or a little over 7 times his initial investment.
Some investors and financial advisors have begun to recommend a pure stock investment for your whole investing career. Since annuities will now guarantee returns on mutual funds held for over 7 years the statistics must be pretty sound that over a long term the return on investment will appear. Sam’s $25,000 invested in good blended mutual funds returning 8% per year for 30 years returns a portfolio worth $250,000 or ten times his investment. I’m not sure sleeping at night from more consistent bond returns is worth $70,000 dollars or an extra $3500 per year for life!
Our last fictitious investor is that fun loving Annie. She is pretty safe with most of her money, but with a little bit of it she wants to buy her favorite small companies, really small companies. This is the point where penny stocks come in. Annie uses 90% of her $25,000 for mutual funds, but the other 10% she spreads over 5 micro penny stocks. One of the micro stocks completely busts while she wasn’t paying attention and she lost it all, three of the penny stocks flounder along at an inflation rate growth of 3%, her mutual funds do what everyone else’s did at 8%, but her one sweet penny stock pick gained 26% a year for 30 years. This is like a Microsoft, Walmart, or many other blue chip stories. Her portfolio grew to the size of almost $750,000!
This is the power of one micro cap stock winner, and she really didn’t risk too much. If you’re willing to use your brain, buy great stocks at great times, and watch them like a hawk so you notice when things change you could really boost your returns while minimizing the risk. Annie would have returned more if she would have dumped her losers before all of 30 years or if she had a stop loss on the one bankrupt stock.
Consider penny stocks as part of your investment plan, but not all of your investment plan, unless you really don’t care if you ever sleep at night._____________________________________