Buying highly-speculative investments such as penny stocks is especially risky. So it’s important to use our three-part philosophy to build your overall portfolio

High-risk, high-reward investors are typically drawn to highly-speculative investments.\

Here’s why that’s not a great long-term strategy.

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Be wary of penny stocks, which are very often highly-speculative investments, to limit your risk

Some investors looking to add to the aggressive portion of their portfolios turn to the higher-risk strategy of buying speculative penny stocks.

However, the odds are against you when you invest in speculative stocks and companies that have yet to make money. Some, if not most, of these companies will never make any money.

There are several potential risks when investors venture into penny stocks.

Buying low-quality penny stocks is one of those things that can appear to be successful before it goes badly wrong. Some investors get hooked on it, since low-quality stocks can be highly profitable over short periods. That’s because they are generally more volatile than high-quality stocks.

Penny stocks tend to be engaged in such things as finding mineral deposits that can be mined at a profit, commercializing an unproven technology or launching new software.

Find out how you can maintain a conservative investment philosophy and still hold some aggressive investments

Most of the aggressive investments we recommend in our Stock Pickers Digest newsletter expose you to more risk than you’ll find in, say, the recommendations of our flagship advisory, The Successful Investor. But you can minimize that extra risk—and expand your profit—by applying the risk-cutting philosophy of The Successful Investor to aggressive investments.

You may invest in more aggressive companies that are less well-established, compared to choices that would appeal to a conservative investor. But you’ll want to stay away from the most highly speculative types of aggressive investments.

For instance, you’ll want to avoid loading up on “penny mines” (speculative mining stocks that have yet to prove their mineral deposits can be mined at a profit). You’ll also want to stay away from “concept stocks”—junior companies that have a business plan but have not yet established a business, much less made a profit or paid any dividends. Stocks like these expose you to a serious risk of total loss. You find a lot of these kinds of concept stocks in the technology industry.

Consider the “sell-half” rule for your highly-speculative investments to safeguard your profits

Knowing when to sell a stock is one of the most important factors in successful investing—it’s almost as important as knowing when not to sell. That’s why we advise investors to follow a key rule when it comes to rising stocks.

Selling part of your holdings of hot stocks that surge helps you guard your profits. But we generally apply this rule only to more aggressive stocks, and not to the well-established stocks that may surprise you by going a lot higher in the long run.

Whether your approach to investing is conservative or aggressive, the quality of your investments matters much more than your skill at selling.

However, you should be quicker to sell aggressive stocks than conservative ones. With stocks we rate as “Speculative” or “Start-up,” it pays to apply our sell-half rule. That’s when you sell half of a stock that doubles in price.

Avoid highly-speculative investments in marijuana stocks and stick with established producers for safer stock picks

We advise staying out of stock promotions of Canadian marijuana businesses or other speculative ventures. They attract the wrong kind of people. Stock promotion is a take-the-money-and-run type of business. Most successful entrepreneurs value their reputations, and want to build a profitable, sustainable business that can pay off for investors. So they generally stay out of stock promotions.

While the marijuana industry now has a number of established producers, in the early stages of decriminalization we also saw many highly speculative “pot-of-gold” penny stock promotions. These typically arise in new industries.

A stock promotion launched by penny stock promoters is usually the work of their marketing departments or a public relations firm. Penny stock promotions are created to make a penny stock appear more valuable than it actually is. That’s because it’s much easier to launch a penny stock promotion than it is to create a successful, lasting business.

Use our three-part Successful Investor philosophy to make better stock picks—including aggressive stocks

1. Invest mainly in well-established, dividend-paying companies;
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; Utilities);
3. Downplay or avoid stocks in the broker/media limelight.

What has your experience been with speculative stocks? Do you think they are worth the risk?