Fractional Share

Introduction

A fractional share is a portion of an equity stock that is less than one full share. Traditionally, stocks are bought and sold in whole share quantities, but with the advent of online trading platforms and a shift towards more inclusive investment options, the ability to purchase fractional shares has become increasingly popular. This innovation allows investors to diversify their portfolios and invest in companies whose stock prices may be prohibitively high in full-share increments.

How Fractional Shares Work

Fractional shares are typically created as a result of various circumstances, such as stock splits, dividend reinvestment plans (DRIPs), and mergers or acquisitions. In recent years, many brokerage firms have begun offering investors the ability to purchase fractional shares directly.

  1. Stock Splits: When a company issues a stock split, existing shares are divided into multiple new shares. For instance, a 3-for-2 stock split would convert each 2 shares a shareholder holds into 3 shares. This can result in fractional shares if the shareholder does not hold the requisite number of shares to be evenly divided.

  2. Dividend Reinvestment Plans (DRIPs): When companies issue dividends, some shareholders opt to reinvest these dividends back into purchasing additional shares of stock. This often results in the acquisition of fractional shares since the dividend amount may not be enough to purchase a full share.

  3. Brokerage Purchase Programs: Many modern brokerage firms such as Robinhood, M1 Finance, and Fidelity now offer fractional share investing as an explicit feature. This allows investors to specify the dollar amount they wish to invest rather than the number of shares, thus facilitating the purchase of fractions of shares.

Benefits of Fractional Shares

Investing in fractional shares comes with a number of advantages that are particularly appealing to individual investors.

  1. Increased Accessibility: High-priced stocks, such as those of major tech companies, can be out of reach for small investors. Fractional shares lower the entry barrier, allowing more people to invest in high-value stocks without needing to commit large sums of money.

  2. Enhanced Diversification: With the ability to purchase fractional shares, investors can diversify their portfolios more easily. Instead of investing in a few whole shares of a single stock, they can spread their investment across multiple stocks and sectors, thus mitigating risk.

  3. Reduced Cash Drag: Fractional shares allow for a more efficient use of capital. Investors do not have to leave unused funds sitting in their brokerage accounts when those funds can be fully invested in fractional shares.

  4. Ease of Reinvestment: Reinvestment of dividends or leftover funds from sales can be seamlessly directed into purchasing fractional shares, allowing continuous compounding and growth of invested capital.

Drawbacks of Fractional Shares

While the benefits are numerous, there are some potential downsides to consider when investing in fractional shares.

  1. Liquidity Issues: Fractional shares might not be as liquid as whole shares. If an investor needs to sell fractional shares, it could potentially be more challenging, depending on the policies and execution capabilities of the brokerage.

  2. Brokerage Dependence: Fractional shares are often non-transferable. This means that if an investor decides to switch brokerage firms, they might need to sell their fractional shares and reinvest that money through the new broker, potentially incurring transaction fees.

  3. Complex Pricing: The price of fractional shares might differ slightly from the whole share price due to rounding and broker-specific pricing policies. Investors need to be aware of these potential discrepancies.

  4. Limited Voting Rights: Companies typically offer voting rights to shareholders, but these rights might be limited or non-existent for fractional shareholders depending on the company’s policies.

Robinhood

Robinhood is a fintech platform that has popularized commission-free trading among retail investors. Robinhood offers fractional share trading, allowing investors to purchase slices of thousands of stocks and ETFs starting from as little as $1.

M1 Finance

M1 Finance is a financial services company that combines the features of a robo-advisor and a brokerage. M1 Finance allows investors to build a customized portfolio and purchase fractional shares, providing a sophisticated way to execute diversified investment strategies with any amount of money.

Fidelity

Fidelity is one of the largest and most established brokerage firms in the world. Fidelity has embraced the trend of fractional share trading, offering its customers the ability to buy fractional shares through its “Stocks by the Slice” program, enabling investors to own portions of stocks and ETFs with just $1.

Charles Schwab

Charles Schwab provides a wide range of investment services, including fractional share trading under its “Schwab Stock Slices” program. This program allows investors to purchase fractions of S&P 500 companies, enabling more people to participate in the growth of major corporations without the need for large amounts of capital.

Interactive Brokers

Interactive Brokers offers advanced trading capabilities for professional investors and institutions. The brokerage has also introduced fractional share trading as part of its services, catering to a broad spectrum of clients from retail investors to high-net-worth individuals.

Tax Implications

Investing in fractional shares has similar tax implications to investing in full shares. Investors may face capital gains taxes when they sell their fractional shares for a profit. Dividends received from fractional shares are also taxable income. It is essential for investors to keep accurate records of their transactions to report gains and losses accurately for tax purposes.

Conclusion

Fractional shares represent an innovative shift in the investment landscape, democratizing access to the stock market. By lowering the barriers to entry and enabling more precise diversification, fractional shares empower a broader range of individuals to participate in wealth-building activities. However, investors should remain mindful of the potential drawbacks and ensure that they understand the policies of their brokerage firm to make informed decisions. Overall, fractional shares are a valuable tool for modern investors looking to enhance their investment strategies.