The post What Are Fractional Shares? by Dan Schmidt appeared first on Benzinga. Visit Benzinga to get more great content like this.
In southern New Jersey, a battle heats up every summer on the boardwalk in Wildwood. It’s not a battle over politics or sports but something far more relatable and crucial to everyday life — pizza. The battle is Sam’s vs Mack’s and everyone has an opinion over which is better.
The big selling point for both shops is that you can buy a single slice while walking down the boardwalk and then continue on your way. Now imagine you couldn’t just buy a single slice but instead had to buy an entire pie to get pizza. What do you do if you’re by yourself and don’t want eight slices? And why would you pay for a full pie when you really only wanted a slice or two?
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Many new investors run into a similar problem when they begin building a portfolio. Stocks can be purchased in increments as small as one share, so the prevailing wisdom is to think of a share as a slice of the company’s pie or equity. But then look at a company like Amazon or Google — a single slice of that pie will cost over $2,500.
Let’s re-imagine each share as a pie. That share can be cut up and distributed to investors who wish to build a diversified portfolio but can’t afford to fill it with individual shares of Amazon, Google or other four-digit-priced stocks. If that sounds like a good idea to you, you’ll be happy to know it already takes place at many brokerages.
Fractional shares allow capital-light investors to assemble diverse portfolios without needing to add leverage, borrowed money or an investment vehicle like an exchange-traded fund (ETF) or mutual fund.
Overview of Fractional Shares
A fractional share is a small piece of a share sold to investors who cannot afford to buy a full share. A fractional share isn’t purchased by entering the number of shares you want in a traditional buy or sell order. Instead, you enter the dollar amount you wish to spend on a certain stock and own the equivalent share fractions of that dollar amount.
For example, if you wanted to buy 10 shares of Amazon, you’d need about $33,000 to complete the order since each Amazon share is over $3,300 in August 2023. But if you wanted to buy $1,000 worth of Amazon, you’d purchase 0.3 shares from a broker offering fractional shares.
Where do fractional shares come from? If you have a retirement plan with an automatic dividend reinvestment option, you likely have purchased fractional shares already. Fractional shares can also be created from stock splits, mergers and acquisitions or capital gains distributions. Today, many brokers allow clients to purchase partial shares directly.
Why Invest in Fractional Shares
The main reason investors purchase fractional shares is that they have limited capital and wish to build a diversified portfolio without resorting to ETFs or mutual funds. When buying ETFs, you rely on the decisions the index or fund manager as far as holdings. And mutual funds are the same way, minus the advantageous tax structure. Buying fractional shares allows someone to own multiple individual stocks in various sectors without a five-digit sum of capital.
For example, if you have $4,000 to invest, you could have to choose between Amazon and Google if your minimum buy was one share. But with fractional shares, you can buy $2,000 worth of each company. Or $1,000 of each, plus a few full shares of Apple or Meta Platforms. You can buy or sell these shares when it suits your investment plan as well.
Another advantage of fractional shares? Dollar-cost averaging. You can invest the same amount in your brokerage account each month, week or day with fractional shares. Dollar-cost averaging is a proven strategy because investors capture upside by investing consistently in downturns while also limiting declines with periodic rebalancing. Buying low and selling high sounds easy in theory, but people tend to get emotional when money is involved. Dollar-cost averaging creates a plan that investors can stick to.
Disadvantages of Fractional Shares
Fractional shares have some downsides as well. For starters, you’ll need to make sure you aren’t killing your account with a thousand papercuts. If fractional share purchases come with commission, you’ll need to be cautious not to rack up trading fees.
Stock selection can also be a concern. Some brokers may have a diverse group of fractional share offerings, but there’s no guarantee the particular stock you want will be there. Additionally, transferring fractional shares from one broker to another is often a headache-inducing process so pick a broker you like.
But the biggest issue with fractional shares is liquidity. Finding a counterparty to buy and sell fractional shares to is more difficult than whole share orders. A lack of liquidity could mean holding shares longer than you previously anticipated and accepting declines beyond your pre-planned limits.
Where to Buy Fractional Shares
With more investors participating in the stock market thanks to commission-free online brokers and the popularity of meme stock investing, fractional shares are highly sought after. Brokers offering fractional shares include Cash App, SoFi Invest, E*TRADE and TD Ameritrade. Be sure to check with your particular broker of choice for stock availability and ask plenty of questions about fees and commissions. Here are a few of Benzinga’s favorite brokers offering fractional shares.
Charles Schwab is a solid choice for traders of all skill levels. It offers full access to the U.S. equity and options markets as well as 30 international markets. Traders can create a diverse portfolio with $0 commissions and no account minimums. Schwab’s margin trading is expensive but Schwab makes up for it with affordable futures and options trades, along with a comprehensive mobile offering.
Best For
- 3 trading platforms perfectly in sync makes matching your platform to your skill level a snap
- Excellent futures trading education for new traders
- $0 account minimum means anyone can start trading
- Wide range of available assets to trade, including futures and 30 global markets
- SmartStreet Edge platform is powerful enough for advanced traders, yet easy enough for new traders to utilize
- Unique educational resources (like infographics and podcasts) make learning fun
- Margin rates are more expensive than competitors
- More limitations on available margin than competitors
- Expensive mutual funds
Interactive Brokers is a comprehensive trading platform that gives you access to a massive range of securities at affordable prices. You can buy assets from all around the world from the comfort of your home or office with access to over 150 global markets. Options, futures, forex and fund trading are also available, and most traders won’t pay a commission on any purchase or sale.
IBKR is geared primarily toward experienced traders and investors but now with the availability of free trades with IBKR Lite, casual traders can also acclimate to IBKR’s offerings.
Best For
- Access to international markets
- Active traders
- Sophisticated investors
- Detailed mobile app that makes trading simple
- Wide range of available account types and tradeable assets
- IB SmartRouting provides significant price improvement vs. industry
- Fractional trading allows investing regardless of share price
- Industry’s lowest margin rates
- Earn more by lending your fuly-paid shares
- Beginner investors might prefer a broker that offers a bit more hand-holding and educational resources
Robinhood is a broker designed for traders who want a simple and easy-to-use platform. It takes out all the bells and whistles that can be confusing to the modern day trader, serving as the perfect place for beginners to learn the markets. The interface is intuitive and easy to master, streamlined to ensure you don’t get distracted as you build a portfolio. Though advanced traders might like more thorough analysis tools, Robinhood gives you everything you need to start trading and learn the ropes.
Best For
- Beginner traders
- Mobile traders
- Streamlined, easy-to-understand interface
- Mobile app with full capabilities
- Can buy and sell cryptocurrency
- Fewer analysis tools than most
Fidelity is a comprehensive and responsive brokerage suitable for both new and experienced traders alike. With complete access to the full U.S. stock and options markets, a set of state-of-the-art education and research tools, as well as a wide fee-free fund selection, Fidelity is equally useful for the veteran swing traders to novices opening their first accounts. Mobile traders will be especially happy with Fidelity’s app, which mirrors full capabilities of the platform. Though there isn’t much to criticize about Fidelity, the broker does have a few areas where it can afford to improve. Margin rates are significantly higher than most other brokers, especially for traders borrowing less than $25,000. It also doesn’t offer any access to the futures markets. Despite these minor flaws, Fidelity remains a strong choice for most investors.
Best For
- Easy-to-navigate yet functional platform strikes the perfect balance between expert tools and comfort for beginners
- Mobile trading app is fully-optimized and mirrors full functionality of the desktop platform
- Wide range of education and research options make learning more about securities and the market easier and less time-consuming
- Complete range of both independent and managed services available at exceptionally affordable prices
- Offers access to both domestic markets and 25 foreign markets, as well as a wide range of options contracts and over 10,000 mutual funds
- Mobile app that is well-integrated and works just as well as the desktop platform
- Wide selection of education tools and resources available free of charge
- Margin rates higher than many other competing brokerages
- No access to futures trading
- High fees for buying a non-Fidelity mutual fund (with over 3,300 fee-free funds available)
Other brokers offering fractional shares include Cash App, SoFi Invest, E*TRADE, and TD Ameritrade. Be sure to check with your particular broker of choice for stock availability and ask plenty of questions about fees and commissions.
Democratizing Investing
“Democratize investing” is a phrase thrown around by brokers like Robinhood who want to get new investors into the fray. Most of the time, it’s used as a marketing slogan to get new signups but adding fractional shares and selling them commission-free is a way to let new investors build diverse portfolios without requiring a mountain of money to start.
Buying index funds in a 401(k) is a sound retirement strategy, but many young people would like to build stock portfolios in taxable accounts and don’t have the funds to diversify. Fractional shares put diversification in reach for everyone, regardless of income. Just be sure to understand the additional risks that come with partial shares.
Frequently Asked Questions
What if I buy fractional shares and later there’s a stock split?
If you buy fractional shares and later there’s a stock split, you still benefit from the stock split. A stock split occurs when a company decides to divide its existing shares into multiple shares. For example, in a 2-for-1 stock split, each share is split into two shares, effectively halving the price per share. If you own fractional shares, your brokerage account will automatically adjust the number of shares you own after the stock split, ensuring that you still maintain the same proportion of ownership in the company.
Can I buy exchange-traded funds as fractional shares?
Yes, it is possible to buy ETFs as fractional shares. Many brokerage firms offer the option to purchase fractional shares of ETFs, allowing investors to buy a portion of a share instead of a whole share. This can be particularly beneficial for investors who may not have enough capital to purchase a full share or want to diversify their investments across multiple ETFs with smaller amounts of money. Fractional share investing can provide more flexibility and accessibility to a wider range of investors.
Are fractional share rules the same across all brokers?
No, fractional share rules are not the same across all brokers. Each broker may have their own specific rules and regulations regarding fractional shares, such as minimum investment amounts, availability of certain stocks or ETFs for fractional trading and associated fees or restrictions. It is important for investors to research and understand the fractional share rules of their chosen broker before engaging in fractional trading.
The post What Are Fractional Shares? by Dan Schmidt appeared first on Benzinga. Visit Benzinga to get more great content like this.
