Over the last ten years, the rise in popularity for fractional shares has helped to usher in a wave of new investors. Fractional shares along with the subsequent rise in commission-free trading paved the way for a record number of young, first-time investors to enter the market.
One of the biggest reasons for this is because fractional shares have made investing much more affordable. “Fractional investing has played a major role in making the stock market more accessible and more approachable to new investors,” says MaryAlexa Divver, director of product at Public.com.
Previously, retail investors would need to have thousands of dollars to invest in an expensive stock like Amazon, for example. Now, they can own a slice of Amazon with as little as $5, so they can build a diversified portfolio no matter their investing budget.
What is a fractional share?
A fractional share gives an investor the opportunity to own a small portion, or fraction, of one whole share of a stock. Exchange-traded funds — index funds that can be traded throughout the day — can also be bought as fractional shares.
This can benefit investors in multiple ways. “They democratize access to ownership in companies that investors with smaller amounts would not be able to get otherwise. This benefit then allows investors with smaller portfolios an opportunity to diversify their investments rather than having to allocate their entire balance to one higher priced share,” says Tara Falcone, CFA, CFP®, founder of fintech company, ReisUP.
The ability to buy and sell fractional shares is relatively new for retail investors, but the concept of fractional shares has been around for quite some time. For example, if you participate in a dividend reinvestment plan (DRIP) this often results in owning a fractional share.
An investor may also end up owning fractional shares as a result of a merger or stock split. If a company does a 3-to-2 split, you’d own three shares for every two shares that you own. In this case, an investor with nine shares would end up having 13.5 shares.
How do fractional shares work?
Fractional shares in most aspects work the same as full shares. Fractional shareholders receive the same percentage gains and losses as those with full shares and may also receive the same benefits such as voting rights, depending on the brokerage. If the company pays a dividend, fractional shareholders are entitled to receive that as well.In most cases, you can buy and sell fractional shares with the same ease as whole shares — but there can be a few disadvantages that you should be aware of, which we’ll cover in the next section.
Are fractional shares worth it?
Upon first learning about fractional shares, a natural question is: “Are fractional shares really worth it?” The answer is yes. There’s a misconception that you need to work toward owning one full share to achieve the full benefit of stock ownership and that isn’t the case.
“It’s important to remember that investment returns are relative,” says Falcone. “If a stock’s price increases 10%, you’ll earn 10% on your investment whether you own a fraction of a share or hundreds of shares.” Fractional shares can also make it much easier for investors to diversify their portfolio across dozens of stocks at a much cheaper price point than owning full shares.
But there are some downsides to be aware of: For example, not all brokerages at this point in time offer fractional shares. Some brokerages only allow you to trade fractional shares with certain companies.
For example, Charles Schwab currently allows fractional share trading for stocks in the S&P 500. “Investors may run into difficulties transferring fractional shares from one brokerage account to another if they want to move their portfolio to a different provider,” says Falcone. This means that you may have to sell some or all of your fractional shares to make the transfer which may have tax implications.
How to Buy Fractional Shares
In order to buy fractional shares, you will need to open an investment account through either an online broker or a robo-advisor. The main difference between the two is whether you want to have full control over which fractional shares you are investing in, or if you want to have a more hands-off approach. With a robo-advisor, you will be able to set your dollar amount to invest and your investment goals, and based on that, the robo-advisor will choose your fractional share investments and automatically rebalance to keep you within your investment goal range.
Step 1: Research the fractional shares you want to buy. Fractional share offerings will differ between brokerages, so knowing which stocks you want to be able to invest in via fractional shares can also help determine which brokerage you may want to use.
Step 2: Open an online broker or robo advisor account. Not all online brokers or robo-advisors offer fractional shares, so you will need to make sure the company you want to go with offers that service. It is also important to remember that every brokerage has slightly different nuances to the way they offer fractional shares, such as:
- Which stocks can be bought in fractional shares
- How trades are executed and settled
Step 3: Fund the account. You will need to fund the account once you open it. Many online brokers can be funded via electronic funds transfer, but it still may take a few days for the funds to settle, so you may not be able to invest right away.
Step 4: Complete and monitor your investment. Most online accounts make it very easy to monitor your portfolio using the main dashboard. Typically, you are able to see all of your account holdings at a glance, but you may also be able to utilize more advanced options, such as setting up stock alerts or automatic rebalancing, depending on what is offered by your particular online brokerage.
Is There a Downside to Fractional Shares?
While there are several benefits to investing in fractional shares, the following drawbacks are also worth considering:
Limited stock selection: Just because a stock is publicly traded does not mean that you will be able to buy fractional shares of it. Each brokerage has their own curated list of stocks that investors can buy fractional shares of.
Potential problems transferring fractional shares to a different broker: If you want to transfer your account to another brokerage, you may not be able to transfer the fractional shares. You may need to liquidate any fractional shares in order to transfer.
Proxy voting may not be an option: Again, each firm also handles proxy voting differently regarding fractional shares. Make sure you know your company’s policy on this ahead of time.
Additional fees: Some brokerages charge additional fees for fractional share investing. This can potentially decrease profits, especially for low-dollar investment amounts. Find out if there are fees associated with fractional shares and if they are flat fees or a percentage.
Trade execution may not take place in real time: If the brokerage that you are investing with does not settle your trade in real time, that could affect your cost basis. Some firms will settle all the fractional shares in one or more bulk orders rather than settling each order individually. Obviously, prices can fluctuate throughout a trading day, so understanding how this will be settled is important.
Can complicate tax returns: Because you are buying fractional shares, and may buy several fractional shares throughout the year, depending on your investment strategy, you may end up holding several different tax lots that may be difficult to match up at tax time. If a stock you own has a dividend that you automatically reinvest, you will have additional tax lots to deal with.
Factors to Consider When Investing in Fractional Shares
Selection of stocks and ETFs available for fractional share investing: Because each online brokerage has its own select list of stocks or ETFs that they offer for fractional share investing, it is important to know this ahead of time. Some firms will offer ETFs, others will not. One company may offer fractional shares of an individual company, while others may not. Be sure to check out each brokerage’s list of fractional share stocks and ETF offerings before opening an account.
Fees and commissions: Some brokerages will be commission-free when it comes to investing in fractional shares, while others may charge additional fees. It is important to find out the brokerage’s policy on this prior to opening an account.
Account minimums: Many companies have no account minimum to open or maintain the account. Often, investors can buy fractional shares for as low as $1. Balance and investment minimums will differ from broker to broker.
Research amenities: Once you open an account with an online broker or robo-advisor, you will have access to research amenities. Brokers will provide analysts’ assessments of companies, which can help you determine which stocks you’d like to invest in.
Educational content: Knowing how to invest, what to invest in, and how to reach your financial goals are important. Educational content provided by your brokerage can help you to better understand which investments will help you reach your goals, and even how to better utilize your account amenities to track and monitor your investment.