If you’re willing to risk ‘play money’
Q. I’ve been thinking of making a new account with play money for penny stocks — sort of like playing the lottery. Are there any negatives if I can afford to lose the money?
A. More than 50 million Americans play at least $1,000 annually in the various lottery games.
The top 5 percent of people who play the lottery are spending a few thousand dollars per year or more than $100,000 on average in their lifetime, said Altair Gobo, a certified financial planner with U.S. Financial Services in Fairfield.
“The chance of winning the Powerball is estimated at 1 in 292 million,” Gobo said. “If these same people invested $2,000 per year at 2 percent over 40 years they’d have about $120,000.”
Penny stocks are equities that trade below $5 per share. They are too small to be listed on the NYSE or NASDAQ, so they are traded Over The Counter (OTC) or by the Pink Sheets.
“So, these stocks typically don’t get the exposure of the investment mainstream and for the most part are traded online,” Gobo said.
These stocks share some characteristics, he said. For starters, “Get Rich Quick.” You’re encouraged to find that small company with the “latest and greatest” that is soon to be discovered by the rest of the investment world.
And they have a cheap price. You can buy a lot of shares for little money. So 1,000 shares of a 50-cent stock that moves to $3 can return a profit of $2,500, while if the stock goes bust you “only” lose $500, Gobo said.
Alison Williams, a certified financial planner with Stonegate Wealth Management in Oakland, said with great risk, sometimes comes great reward.
“On the opposite side of the spectrum to losing money, you could experience a large amount of income,” she said. “If you’re investing large sums of money, a holding skyrockets and you need to liquidate, you could have large capital gains/tax ramifications.”
She said having a play account can help investors become more familiar with the market and trading process.
But, penny stocks are very volatile.
“Sold in small lots to a few investors, price swings can be exaggerated.,” Gobo said “As fast as some of them can go up — they can fall a lot faster – not for the faint of heart.”
And because they are so thinly traded, unfamiliar to most and minimally regulated, they have become prime targets for fraud – whether it’s price manipulation or shoddy promotions, Gobo said.
One of the classic shams, Gobo noted, is the so-called “pump and dump” where the perpetrators trade among themselves, raising the price (pump), then selling the inflated shares to unsuspecting investors (dump) in order to generate a profit for themselves.
“If you do no research at all and pick these stocks blindly, I suppose you’re no worse off than playing the lottery,” Gobo said. “As long as you can `afford to lose the money’ I suppose the one real negative would be that you get taken by the `crooks’ — remember pump and dump).”
Also, he said, these investments do not tend to be `buy and hold.’ So if you make a few bucks, it may be wise not to get greedy and take some money off the table, Gobo said.
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Karin Price Mueller writes the Bamboozled column for The Star-Ledger and she’s the founder of NJMoneyHelp.com. Click here to sign up for the NJMoneyHelp.com weekly e-newsletter. Like NJMoneyHelp.com on Facebook and follow it on Twitter.