Should You Take a Flyer on a Penny Stock?

Every now and then, I get a note from a reader whose spouse or friend has gotten excited about a stock tip. Usually, it comes with a backstory: someone they know bought a few thousand shares of a penny stock and now claims to be sitting on a massive gain.

Naturally, the question that follows is:

“Should we throw a few thousand dollars at this and see what happens?”

The opportunity might look enticing at first glance:

I don’t like to comment on individual stocks, and I’m not sharing the name of this particular example because it’s not important.

But what I like to do is zoom out on the lifetime returns of the company for some better insight:

Ouch! That’s a lifetime loss of 99.89% since inception.

Table of Contents

Penny Stocks Are the Lottery Tickets of Investing

Penny stocks are seductive. They’re cheap, the story sounds compelling, and there’s always a friend-of-a-friend who allegedly turned $1,000 into several hundred thousand dollars.

But the odds of that happening? Let’s just say you might have better luck with a scratch ticket.

This is where the data comes in. A recent episode of the Rational Reminder podcast discussed research on the skewness of individual stock returns.

The key insight? Most individual stocks don’t outperform T-bills over their lifetime. In fact, a tiny sliver of stocks – about 4% of all publicly traded companies – are responsible for nearly all the wealth creation in the stock market.

In other words: if you’re investing in individual stocks, the chances of picking one of those needle-in-a-haystack winners are vanishingly small.

“Let’s Just Put In a Couple Thousand and See What Happens”

This might be the most expensive sentence in investing.

It sounds innocent enough. What’s a couple thousand bucks in the grand scheme of things? But let’s game this out:

Scenario A: The stock goes 10x

You turn $2,000 into $20,000. That’s exciting! But does it change your life? Probably not. It won’t help you retire early. It won’t buy you a house. It might buy you a slightly nicer used car.

Scenario B: The stock goes to zero

You lose $2,000. That stings. Not enough to bankrupt you, but enough to make you feel foolish – especially if you had misgivings about the idea in the first place.

The upside is limited in its impact. The downside is more painful than you think. That’s because of loss aversion – a behavioural bias where the pain of losing money feels roughly twice as powerful as the pleasure of gaining it.

In other words, losing $2,000 hurts a lot more than winning $2,000 feels good.

And what usually happens is something in between. The stock falls 40%. Then you feel tempted to “average down.” Or you hang on too long. Or you panic and sell. Either way, it becomes a distraction.

The Boring Path to Wealth

Here’s the truth: investing isn’t supposed to be exciting. It’s not supposed to feel like a hot tip or a gamble. It should feel like watching paint dry – slow, steady, and kind of dull.

Broadly diversified, low-cost index funds capture the returns of the entire market, including the tiny handful of stocks that go on to become the next Apple or Amazon. You don’t need to guess who the winners will be. You just need to own the haystack.

So if your partner wants to take a flyer on a penny stock, set clear boundaries. Call it “fun money,” keep it to 1% of your portfolio (or less), and treat it like a trip to the casino. Because that’s what it is.