Is buying penny stocks ever a good idea?

I’m a 23-year-old who has a little bit of savings and a lot of curiosity about the stock market. But I don’t know where to start. How can I participate in the best way? And are penny stocks ever worth it? I realize they’re more speculative than blue-chip stocks, but some people seem to make a killing on them.

– Aspiring Warren Buffett

Dear AWB,

I remember when I was a curious 23-year-old. I tried all manner of things, some of them even legal. Some of them were lots of fun, some of them turned out to be much less enjoyable than I had thought they would be. But I don’t regret any of my youthful experimentations. 23 is the perfect age to make mistakes.

So, you’re curious about the stock market? The best thing to do is to approach it in the same way you’d approach other things you’re curious about. Read a bit about it, maybe dip your toe in the waters gently, see what happens. Learning by doing is pretty effective, and much more effective than reading scolding advice columns.

That said, stock-market investing is always a means to an end. No one talks about “stocks and drugs and rock ‘n roll”: there’s no innate pleasure in placing an order to buy five shares of IBM at market. So, ask yourself this: why are you buying stocks? There are basically two possible answers.

The first answer is “I want to make a killing, and get rich quick.” You are not the first person to want this, nor will you be the last. But that’s definitely not the Warren Buffett way of doing things: his slogan is “get rich slowly”, and in any case, as he would be the first to admit, his own particular way of getting rich, back in the 1960s, can’t be easily replicated 50 years later.

Penny stocks are superficially attractive to people who want to make a killing and get rich quick. If a stock goes from 10 cents to 20 cents in a week (and that happens all the time), then you’ve doubled your money! Do that once a month, and you can turn $1,000 into $4 million in the space of a single year!

There’s only one catch: no one has ever done this.

Here are some better things to do with your money than buy penny stocks:

1. Take all the tissues out of your tissue box and replace them with dollar bills.
2. Shred it and use it as confetti on New Year’s Eve.
3. Use it as a phone.
4. Make origami.
5. Give it to the least responsible person you know and ask him or her to earn you money.

Penny stocks are never worth it: the only way to consistently make money in penny stocks is to be a sleazy boiler-room pump-and-dump merchant. You have no way of predicting which stocks will go up, but you do know which stocks are being hyped: they’re the ones you’re looking at, because you’re reading about them on the internet. And the one thing I can guarantee you is that if you’re looking at a stock that’s being hyped, then you’re the sucker who’s looking to buy at the top, rather than the operator who bought low.

So, maybe don’t buy penny stocks? You can still invest in the stock market! You just shouldn’t do so with a get-rich-quick mentality. Lots of boring, sensible people put money in stocks as part of their long-term savings plan. Warren Buffett understands that stocks are permanent capital, and as such he wants to buy the stocks of companies that are going to be around forever. He doesn’t trade in and out; he just finds companies he likes, like Coca-Cola or American Express, and holds them more or less in perpetuity. Over a period of decades, his stocks go up a lot, and he gets very rich. (It also helps, of course, that he’s using other people’s money to buy those stocks, thanks to the fact that he owns a massive insurance company.)

The bad news is that buying stocks as part of a long-term savings plan is not something you can really experiment with. You can trade penny stocks no problem, put a little money in, watch it disappear, learn your lesson. But if you buy a diversified basket of blue-chip equities with the expectation that they’ll be worth a lot more in 40 years, there’s no real way of seeing whether it works, other than waiting 40 years. Stocks go down as well as up, and if you have a nice diversified basket of stocks—like an ETF that mirrors the S&P 500—then statistically speaking you’re extremely likely, at some point before you retire, to see that diversified basket fall in value by 30% or more. As a result, if your stocks go down rather than up, that doesn’t mean you’re doing it wrong. It just means that stocks are volatile things which sometimes go up and sometimes go down.

Some people think they can solve this problem through something called “market timing.” The idea is, you buy stocks when they’re going up, sell them when they’re at their peak, and then sit on the cash until they bottom out, at which point you buy them again. You get all the upside, and none of the downside!

Again, this works great in theory. But again, no one has ever successfully done it.

The simple and sensible way to participate in the stock market is probably just to sign up for an account at Betterment, or a similar robo-advisor. If you want to take on more risk, you can dial up the risk and your stock exposure; if you feel like you’re investing money you can’t afford to lose, then you can be more conservative. Then, just set it and forget it. It’s not exciting, it won’t make you a billionaire, and you won’t learn very much about the stock market in the process. But it will help you get rich slowly.