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Boatman: Be wary of the penny stock market

| Wednesday, June 11, 2014, 12:01 a.m.

This week we are going to discuss some ways to own equities.

Many people get their first exposure to the stock market from their 401k. You have so much taken out of your pay each payday and invest it in a 401k. Your employer may match up to a certain level. Besides the free money from the company match, this is good because it is a way to pay yourself first. Paying yourself first is an important part of building savings.

This means that you set aside a certain amount every payday and then use the balance of your money to pay your bills and live on. If you try to pay yourself last, there will often not be any money left over for savings. It is very important that you pay all of your obligations on time to maintain your credit record. The reason paying yourself first works is that many purchases we make are discretionary or impulse. We can often consider different choices for that money.

Another benefit of 401ks is you contribute over a long time span. When markets are down, you buy more shares for your investment. When markets are higher, you get fewer shares but you are dollar-cost averaging. You also get tax deferred growth. While this works well while you are employed, it is not always as beneficial when you leave the company. You are no longer getting a match for your contributions, fees tend to be higher and you have a limited selection of investment choices. This is why it may be beneficial to do a tax-free rollover.

Another way many people own equities is in variable annuities. These are a favorite of many stockbrokers or registered representatives because they generate a lot of income for them. You pick from a limited source of fund options. Since the structure is an annuity, you get tax deferral and some different rider options. These may provide a guaranteed income option or a death benefit among others. It is not unusual to see fees of 3.5 percent in a variable annuity.

Sometimes, you are paying for a rider that may have limited benefits for you. If you turn on the income rider, your death benefit value is often severely affected.

Insurance companies are in the business of insuring risk. All companies are good at predicting life expectancies. Variable companies also have to insure market risk such as happened in 2008. Since fixed annuity companies do not have market risk, they can often pay higher lifetime incomes. Make sure that you compare if this is an area that you need.

Variable annuities can change the amount of taxes you will owe the government from capital gains to ordinary income.

Capital gains tax rates are lower. Also, remember that the death benefit in annuities is not totally tax-free as in life insurance.

Some people invest in penny stocks. This can be a very risky investment. Penny stocks are usually a couple of dollars or less per share. Investors hope to find a new superstar company that will turn into the next big thing. This is nearly impossible to find. This is especially true today because with the information age we live in, everyone has already heard about these companies. If they invented a really revolutionary product, there is a good chance a bigger company would have swooped in and already bought it.

There are a lot of schemes in the penny stock market. The government has prosecuted numerous people for manipulating the market. These people will create false rumors and artificial demand to make a company look better than it is. This is much like the movie “Wolf of Wall Street.” They use pump-and-dump schemes to create an illusion and take people's money. Often they will use false press releases to try and inflate a company's value. Even if you somehow found a company in this market, they face many daunting challenges. Most people should never consider penny stocks.

You will be hearing in the news that Apple stock is splitting. This means that Apple's board of directors was concerned that its share price of almost $700 per share was too high to attract many individual investors. After the spit, shareholders will own exactly the same dollar value as before the split. If it is $700 and splits seven ways, you now own 7 shares worth $100 per share for a market value of $700. Companies sometimes do this to make their share price more attractive to investors. They believe more people can afford a $100-stock than a $700-stock.

Gary Boatman is a certified financial planner and local businessman who is president of the Monessen Chamber of Commerce.

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