Have you ever wanted to invest in a company’s stock but lacked the funds to buy even one share? Or are you hoping to diversify your portfolio of funds? What if you could invest in stocks without paying the price of a whole share? If this sounds intriguing, allow us to introduce you to fractional shares.
What Are Fractional Shares?
Fractional shares allow investors to purchase a portion of a stock based on a dollar amount they can afford. This strategy can be helpful for investors who start with a limited sum of money but want to build a diversified portfolio.
Think of a company’s share as a complete pie that can be split into many pieces. Each customer can get one or more of these delectable slices to take home, which, as you may have already guessed, are fractional shares. Thanks to fractional shares, limited capital isn’t a deterrent for investing in the shares of a company. With advancements in brokerage technology, fractional shares have gained immense popularity as they allow you to invest in expensive securities and diversify your portfolio. With fractional investing, you can buy stock amounts within your financial means and start investing with even a single dollar.
How Do Fractional Shares Work?
Fractional shares generally result from stock splits, mergers, bonus shares, or acquisitions. Since they do not trade in the open market, they can only sell them through major brokerage firms. Selling the selling stock’s fractional shares can take longer if there is no strong market demand.
Fractional shares are created in many ways:
Stock Splits
Stock splits become available when company officials decide to increase the number of outstanding shares by issuing more to existing shareholders. Companies also do this to enhance their liquidity. Some common stock splits are 2-for-1 or 3-for-1.
Mergers and Acquisitions
Brokerages sometimes split whole shares to sell fractional shares to clients, and this is generally done with high-priced stocks like Alphabet, Amazon, and so on. Sometimes, partial payments can be the only way for an individual investor to buy into such high-value companies.
Dividend Reinvestment Plans (DRIP)
DRIP is a strategy companies use to allow their investors to use dividend payouts to buy more of the same shares. If the dividend sum is not sufficient to purchase a full share, it can lead to the creation of fractional shares.
Advantages Of Fractional Shares
Enhanced Diversification
It allows investors to diversify their portfolios by investing in various companies. Distributing your capital in different company shares also helps reduce the risk associated with changing conditions. Furthermore, it can also help to maximize profits in the long run.
Ability To Invest With Limited Capital
Thanks to fractional investing, you don’t have to save up until you can buy an entire share. For instance, if the market price of the shares of X company is $1000, you don’t have to wait until you have saved $1000. Instead, you can invest whatever amount you have in hand.
Flexibility To Investors
With fractional shares, you can set a predetermined dollar amount you want to buy, and a portion of the share will be given to you. This way, you can buy stocks with a high market share price. It offers great flexibility since you can invest in amounts that align with your investment goals.
Ideal For New Investors
One of the best aspects of fractional investing is that you can lower the risk of your investments while still choosing to fund stocks that intrigue you. For example, if you have a capital of $1000, you can invest $200 in five different companies, distributing the risk while maximizing returns. This allows you to build your portfolio without risking investing large amounts in a single stock.
Limitations Of Fractional Shares
As with every other investment strategy out there, fractional investing also has its share of limitations. Some of the disadvantages associated with it are as follows:
High Prices
Since retail investors can buy shares with fractional investing, the prices of expensive stocks may be inflated, and investing in such companies can be a poor investment decision.
Complications in Trading
Acquiring a fractional share often takes longer than a traditional stock market investment. Plus, tax assessments can also cause complications.
How To Buy Fractional Shares
- Research the fractional shares you want to buy before determining which brokerage you want to use.
- Open an online broker or robo-advisor account. Every brokerage will have slight differences in how trades are carried out and settled, and the fee may vary, too.
- Fund your account. Most online brokers can be funded through electronic fund transfers.
- Monitor your investment portfolio on your online accounts.
Final Thoughts
Fractional shares allow investors to invest small sums of money in expensive securities that would otherwise be unattainable. They also allow investors to divide their investments among more stocks, leading to a more diversified portfolio. Therefore, they can be a great tool for new entrants into the stock market.
Having said that, you must research everything you can about it before deciding to invest in any stock, irrespective of the sum or share.
