If you’re keen on entering the stock market but don’t currently have much money to invest, some of your favorite stocks may seem out of reach. Alternatively, you may have money set aside but don’t want to place it all into a single company. Fractional shares allow you to diversify your portfolio, regardless of your budget.
What is a Fractional Share?
A fractional share is a fraction of a full share of stock in a company. Fractional shares can result from dividend reinvestment plans, stock splits, and other corporate actions. Fractional shares are hard to sell, and typically you can’t get fractional shares from the stock market.
How Are Fractional Shares Created?
Fractional shares are the result of decisions that companies make concerning their stock. Companies create fractional shares in three main ways: dividend reinvestment plans, mergers and acquisitions, and stock splits.
Dividend Reinvestment Plans (DRIP)
Dividend reinvestment plans allow investors to buy more of a company’s shares through a brokerage firm or dividend offerings. Since the dividends do not equate to whole shares, the investors often end up with fractional shares.
Companies that reinvest capital gains or offer dollar-cost averaging investment programs may also end up distributing fractional shares.
Mergers and Acquisitions
In the case of a merger or an acquisition, companies combine to form a new corporate entity. The companies combine their stocks using a ratio agreed upon by both parties.
When a merger occurs, brokerage firms may split shares to make selling shares to retail clients easier. This allows brokers to approach a wider customer base and allows smaller investors to buy into their favorite companies.
Stock splits occur when a company wants to boost its liquidity by increasing the number of shares available. The split doesn’t change the company’s value or the total value of stock shares. Stock splits usually happen as a 2-to-1 or 3-to-1 ratio, which may produce fractional shares.
There is no set point at which a company has to do a stock split. The decision rests on the board of directors. With a higher number of outstanding shares at a smaller price, investors are more likely to purchase the stock.
Reasons for Buying Fractional Shares
Fractional shares offer investors benefits over buying full shares in a company. These benefits are primarily beneficial to retail investors, starting with smaller budgets.
Opportunity to Invest in Expensive Stocks
Buying fractional shares allows you to build a portfolio of stocks whose total stock values are out of your financial reach. Many blue-chip stocks, especially those from Big Tech companies, are up to thousands of dollars per share.
As of March 16, 2022, Google’s parent company, Alphabet, has a stock price of $2,621, while Tesla’s stock has a share price of $829. Spending around $3,500 for a share in each company can keep you from further diversifying into other assets. With the ability to place $100, $50, or less in each stock, you can slowly build up your position without breaking the bank.
Even if you have the $2,621 to buy a share of Alphabet, putting all your eggs in one basket is never a good investing practice. From the top investors in the world like Warren Buffet to minimum wage workers looking to build their retirement fund, diversifying a portfolio helps deal with market volatility.
By allocating a percentage of your money toward companies in different fields, you safeguard your money from losses due to the poor performance of a single company. While billionaire investors have endless amounts of money to diversify across the market, retail investors can emulate this practice using fractional shares.
Maximizing Your Investment with Dollar-Cost Averaging
One of the methods that retail investors use for growing their portfolios is dollar-cost averaging. This practice allocates a set amount per month into an investment account that buys stocks from companies of your choice.
People who use dollar-cost averaging benefit from purchasing fractional shares. During any month, their money will buy fractional shares of stocks rather than sitting in their account waiting to accumulate enough to buy a full share.
For example, if you put $500 aside each month, you will have to wait another month before being able to buy a full share of Tesla at its current price per share. Rather than the money remaining in your account, you can start investing.
If you want to maximize your returns by investing in stocks that pay dividends, you don’t have to worry about drawbacks or penalties when purchasing portions of a share. Buying fractional shares pays dividends according to the percentage you own.
Downsides to Buying Fractional Shares
Choosing to switch to a new broker may be a problem when dealing with fractional shares. While you can transfer full shares without any issues, you may need to sell your fractional shares and start over fresh with your new broker.
Switching brokerage accounts may also cause fees and tax implications due to government regulations. Be sure to check with a knowledgeable financial advisor before moving to a new broker.
How to Buy Fractional Shares
Start by opening an account at a brokerage firm offering fractional shares. Once your account is open, deposit your funds. Some brokerage firms will allow you to start buying shares immediately. Others may take several business days to give you the green light while your deposit clears.
Choose the stock you want to invest in and place an order by listing the desired dollar amount you wish to purchase or the number of shares you are willing to buy. When you choose to enter a dollar amount, you are investing in fractional shares unless you enter the exact value of a full share and your order is filled at that exact price.
Stock prices are constantly changing, and the odds of buying a full share by entering the exact dollar value are slim.
Should You Buy Fractional Shares?
Fractional shares are a great way to get your feet wet in the stock market. Whether you want to invest in companies or a diverse portfolio of stocks with a modest budget, the ability to buy or sell fractional shares can broaden your investing options.
Don’t let a lack of experience get in the way of achieving life-changing returns on your investment. Your retirement and other financial milestones depend on your ability to access the best information on investing. Contact Finance is us to help you avoid rookie investing mistakes and for more information about trading fractional shares or buying stocks and ETFs.
Disclaimer: All content on this site is information of a general nature and does not address the circumstances of any particular entity or individual, nor is the information a substitute for professional financial advice and services.