Cheap Stocks Are an Expensive Mistake — Do This Instead

If you don't have a lot of money but you want to start investing, it may be tempting to search for stocks with a low share price. This could even include penny stocks, which typically cost less than $5 per share.

Unfortunately, while these stocks may seem like an ideal way to get exposure to equities when you have limited cash, you're taking a huge unnecessary risk when you focus on finding companies with the lowest price per share.

The good news is, you don't have to pick low-cost investments even if you have only a few dollars to spend, because there's now a better solution.

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Why cheap stocks can be a bad investment

There are a few big problems associated with buying cheap stocks just because you have a low investing budget:

Many of the stocks with the lowest share prices are penny stocks. These aren't very well regulated, they tend to provide much less information to potential investors, they have low trading volume so can be difficult to buy and sell, and they can be more vulnerable to scams.
A low price doesn't necessarily translate to a good value. A stock may be “cheap” in terms of having a low share price, but it may not even be worth the money you'd pay for it if the company has serious problems or little future potential.

In other words, there are a lot of situations where you get what you pay for — or less — if you're hunting for a bargain and using a low price-per-share as your primary criteria to find it.

What should you buy instead?

The good news is that a low budget doesn't mean you're relegated to buying stocks with a low per-share price. You can buy just about any stock you want, even those that cost hundreds or thousands of dollars per share — even if you have just $5 or $10.

This is now possible because most brokerage firms offer fractional shares. Fractional shares are simply parts of shares, such as 1/20th of a share or 1/100th of a share of stock. Typically, brokerage firms allow you to buy them by specifying how much money to invest in a particular company or fund. If you have $10 and want to buy a stock with a share price of $100, you'd end up with 1/10th of a share.

So why would you want to buy such a small percentage of a share instead of opting for cheap stocks? Because it doesn't really matter how much or how little of a company you own — you still get the same percentage gain if your investment performs well. Whether you buy 1/10th of a share, 1,000 shares, or 1 million shares, if the share price goes up 10%, you end up with 10% more money than you started with.

Since fractional shares mean you can now buy shares of any company you want, regardless of how big your pocketbook is, you aren't denied the opportunity to invest in companies you believe will perform well over time. You stand a far better chance of growing your wealth this way than if you used your $10 to buy a stock with a $1 share price that no one had ever heard of and that had nothing to recommend it besides its low cost of entry.

Different brokerage firms have differing rules when it comes to fractional shares, with some allowing you to invest as little as a penny in a stock and others limiting you to transactions with a $5 minimum. Just find one with features you like that offers fractional share trading, and you can get started.

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