A Fractional share is a portion of a security such as a stock, mutual fund, or exchange traded fund (ETF). They can make investing easier by allowing you to buy a portion of a stock that might be out of your budget range.
If the share cost $400, the brokerage firm might sell one-tenth of the partial shares for $40 each. Sometimes partial shares are created in dividend reinvestment plans (DRIP).
What is the difference between fractional and whole shares?
A whole share is a unit of a company’s stock, a mutual fund, or some other investment. Shareholders may sell them for profit. But they can be very expensive, which puts them out of reach for many investors.
Fractional shares are slices of a complete share, which you might think of as a pie. You can cut the pie into several slices. Many advantages of full shares are also available with fractional shares, but at a lower cost.
How do fractional shares work?
Here’s an example: Ahmed wants to invest $100 in Company M, but one share costs $500.
The brokers offer Ahmed fractional shares in the stock of Company M. Ahmed invests $100 and receives 0.2 shares of Company M, where $100/500$=0.2$.
When the share price of Company M goes up or down, the value of Ahmed’s investment goes up or down in proportion to the fractional share. When compared to whole shares, fractional shares allow you to invest with less money, however they are not available at every brokerage firm and may come with certain fees and restrictions.
If you invest with a brokerage that offers fractional shares, you can buy them as you would any other security, such as whole shares, mutual funds, or ETFs.
To create fractional shares, brokerage firms buy whole shares and subdivide them into fractions, allocating lots to several investors.
This is why fractional shares cannot usually be transferred to a different broker if you switch investment companies. Instead, your broker will buy back your fractional shares. In this case, any profit you make from selling your shares back to the broker will be taxed.
Create fractional stocks through DRIPs
Dividend reinvestment plans (DRIPs), stock splits and mergers can all result in the creation of fractional shares. Even your whole shares might become fractional shares.
Whenever share prices exceed dividends, DRIPs redistribute dividend payments, to buy additional shares of the same investment and convert them into fractional shares.
There are two types of stock splits: a forward stock split, in which more shares are created, and a reverse stock split, in which shares are consolidated to create fewer whole shares. The difference is in the number of shares you ownو the value of your entire investment remains the same.
Benefits of buying fractional shares
The availability of fractional shares has opened new doors for many investors. Because it has a lower cost, it gives you access to a wider range of investments, especially high-priced stocks. So you may be able to start investing sooner and find it easier to diversify your portfolio.
The benefits of investing in fractional shares include:
- Start your investment with a sum that is within your budget.
- Invest in stocks that are compatible with your goals and strategy.
- Obtain access to stocks with higher prices for investing
- Consider making investments in more securities.(Explore investments in more stocks)
- Lots of options available to diversify your portfolio.
Fractional shares allow you to start even if you are money tight, but still earn a return on your money. This is important if you are considering a long-term investment. Even small beginnings can earn you money, and with the power of compounding, they can grow exponentially over time.
Disadvantages of fractional shares
Fractional shares vary between brokerages, and you may find differences in trading policies, costs, and fees. It is important to do extensive research before investing.
Potential drawbacks to take into account are:
- Trading commissions for fractional shares.
- Lower profits and dividends.
- Not having stock’s voting rights.
- Risk of difficult-to-sell, illiquid shares.
- Tax repercussions of switching brokerages.
- Restrictions on what, when, and how you can sell.
Important information to know about fractional shares
- Do fractional shares pay off?
If the security pays a dividend, the fractional shareholders receive a proportionate share. For example, if Company A pays a dividend of $10 per share and you own 0.5 share, you will receive $5.
- Is it better to buy fractional or full shares?
Fractional stocks may be suitable for your portfolio if you are new to investing, or you want to diversify your portfolio without investing a lot of money. It is important to understand the policies and expenses of your brokerage. You may face restrictions or fees that make investing in fractional stocks less tempting (appealing/ not interesting).
- Is it useful to buy fractional shares?
The answer will depend on your financial situation, your investment strategy, and the brokerage you chose. For instance, you might find that the fractional shares are not worth the expanses (effort/fees). Or you might prefer more flexibility to transfer your portfolio; Typically, fractional shares cannot be transferred between brokerage firms, and liquidating them may result in tax liabilities.
However, fractional shares provide a lot of freedom.If you want to know if fractional shares are the best option for you, think about your long-term aims, brokerage fees, and how well their rules match your financial strategy. Keep in mind that all investments involve risks, including the possibility of losing money.
- Are ETFs available as fractional shares?
Each brokerage firm chooses which stock to sell as fractional shares, and some offer fractional shares in ETFs.
- Can you sell fractional shares?
Brokerages allow you to trade fractional shares, however, each has its restrictions and fees. But your brokerage might not guarantee liquidity.
Liquidity is how quickly and easily you can sell your investment without suffering a loss, illiquid shares might be more difficult to sell and result in a loss of capital.
- Are fractional shares included in DRIPs?
A DRIP reinvest your dividends in additional shares of the same security. Because each dividend payment may not be enough to buy a full share of stock, DRIPs usually result in fractional share ownership.
Last but not least, if you really want to buy a stock but the price is too high for you, you may consider fractional shares. When you approach investing piece by piece, you can achieve success.