If you’ve had your eye on a pricey stock but don’t want to invest all your savings in a single company, fractional shares could be an affordable way to get started.
Fractional shares are portions of a company stock that are less than one whole share. Fractional shares let you buy stock based on a dollar amount rather than the number of shares. For example, if you invested $50 in a stock but a whole share cost $100, you'd own half a share. You can also buy fractional shares in exchange-traded funds (ETFs).
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There are several reasons why an investor may want to utilize fractional shares. Here are a few.
To invest in stocks you couldn’t otherwise afford
Fractional shares can help you build the portfolio you want but couldn’t previously afford. For example, if a stock trades for $3,000 per share — which isn't unheard of — you’d need at least $3,000 just to add it to your portfolio. Want to buy more than one share? You’ll have to purchase in increments of $3,000 ($6,000 for two shares, $9,000 for three shares and so on). If you don’t have that much set aside, you’ll need to find another investment. The most expensive stocks can make it difficult to diversify your portfolio if you're on a budget.
But this isn’t the case with fractional shares. Fractional trading lets you buy the amount of stock you can afford, whether that’s $5, $50, $500 or $5,000.
To build a diversified portfolio
Some of the most popular stocks today are also some of the most expensive. Building a well-diversified portfolio consisting of just a few shares of each could require tens of thousands of dollars in upfront capital.
Let’s say you had $6,000 to invest. With fractional shares, you can allocate a certain amount of your money toward each company you want to invest in. If that’s 10%, you could invest $600 worth of stock in 10 different companies, no matter their share price. This helps you build a much more diversified portfolio than if you’d invested a lump sum in a single company.
To get the most out of your investment
If you’re regularly contributing a set amount each month to an investment account (a strategy known as dollar-cost averaging) it’s highly unlikely you’re buying exactly that amount in stock with every contribution.
According to Michael Pappis, a certified financial planner and support manager at Boldin Advisors in Pittsburgh, fractional shares can address this issue.
“Dollar-cost averaging with fractional shares allows you to invest the full amount of the cash you are putting into your investment account on a weekly or monthly basis,” Pappis says. “Whereas without fractional shares, some of your money may have been sitting in cash before there was enough to purchase a full share.”
For example, if you contribute $100 a month and the stock you want to invest in is trading for $55, you’ll be able to buy only one whole share. Without the option to buy fractional shares, you’d be leaving $45 in uninvested cash lingering in your brokerage account.
» New to this strategy? Learn how to use dollar-cost averaging
If you want to transfer your assets to a new broker, it’s unlikely you’ll be able to do that with any fractional shares you own. Whole shares are typically easily transferred, but any fractional shares may have to be sold so you can transfer the resulting cash. Depending on your situation, this could come with tax implications, fees or other unforeseen costs.
Pappis also gives investors a fair warning about buying fractional shares: Don’t let them distract from proven principles, like investing for the long-term.
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“It's important to keep in mind that although fractional shares allow the average investor to participate in the market, it's easier to focus on short-term returns when investing in this way,” he says. “Building wealth takes time and benefits investors with patience and a long-term investment horizon.”
In other words, when it’s easier to buy into the stock market, it’s more tempting to take a very hands-on approach. But the reality is that actively buying and selling stocks is rarely a better strategy than buying and holding for the long term.
Yes, you can buy fractional shares of dividend stocks, but the amount you receive in dividends will be proportionate to how much of the share you own. So, if you invest $25 in a $100-per-share stock with a dividend of $1, your dividend will be only 25 cents.
Stock splits (which happen when a company reduces its stock price, but increases the number of shares you have to make up for it) won’t affect your fractional shares any differently from if they were full shares. If you own 3.5 shares of a company that undergoes a two-for-one stock split, you’ll then own seven shares. But the total value of those shares wouldn’t change.
Yes, ETFs are available through some brokers as fractional shares. As a refresher, ETFs are index funds that can be traded throughout the day just like stocks (compared with traditional index funds, which can only be bought and sold for a determined price at the end of the day). A single ETF can significantly (and easily) diversify your portfolio. Buying multiple ETFs through fractional shares adds yet another level of diversification.
