As you may probably deduce from the name, fractional shares are a form of investment involving the purchase of a portion of a whole share. This concept was necessitated by the realization that many investors may not be in a position to purchase whole shares.
For instance, an investor may be interested in investing in a company, but if the company’s share is sold at $3000, then they may not afford to invest. Fractional shares, therefore, enable a greater number of people to invest in securities markets. This has increased liquidity and boosted trading volumes to the benefit of investors, companies, and brokerage firms.
With fractional shares, you no longer have to worry about the number of shares you can get but how much money you are willing to invest in a company. The beauty of it is that you also stand to benefit from dividends if the company issues dividends to its shareholders. For instance, if you own a quarter of a share and the company gives $20 in dividend for each share owned, it means that you will get $5.
The working mechanism of fractional shares
While fractional investing enables you to own a small portion of a share, securities exchanges don’t accept trading in fractional shares. The actual owners of fractional shares are brokerage firms, who buy them wholesale and sell them to investors in smaller portions.
Not only does this enable investors to buy fractions of shares, but it also empowers them to diversify their portfolios with small amounts of capital. You can buy stocks of different companies across multiple sectors with even less than $500.
A guide to buying fractional shares
- Find a brokerage firm that offers trading fractional shares: Today, many brokers have enabled the buying and selling of fractional shares on their platforms. Therefore, it shouldn’t be difficult to find a brokerage account with decent rates.
- Deposit enough funds in your brokerage account: This will depend on how much you intend to invest in your portfolio. There are several options available for funding brokerage accounts, and many brokers accept wire transfer, credit, and debit card payments.
- Decide on which asset/stock you want to invest in: You should have a good idea of the type of assets you would like to include in your portfolio. Before you pick a stock, you should do your due diligence by evaluating the stock’s performance in the recent past, its current performance, and the fundamental factors that make it a good buy. You should also conduct a technical analysis of the stock to give you pointers as to whether the stock is likely to appreciate or depreciate and whether it is good for a long-term or short-term investment.
- Initiate a buy order: This will depend on whether you think that the stock is correctly valued or not. You may issue a market order to buy at the current market price if you think that the current price is fair or a pending order to be executed when the price goes down if you think that the stock is overvalued and likely to depreciate.
Advantages and disadvantages of fractional shares
- You can own shares with a small amount of capital: With amounts as little as $10, you can buy stocks and experience the world of trading. This has done away with the previous perception that investing in stocks is only for the wealthy.
- You can buy shares of some of the best-performing companies: Most of the high market cap companies have relatively pricey stocks. However, with fractional shares, you can own a piece of such companies and possibly enjoy the benefits of their high profitability.
- Create a diverse portfolio in a small account: If you divide up $100 into $5 stock purchases, you can build a portfolio of 20 stocks. With fractional shares, you can build a diverse portfolio on a tighter budget.
- Limited options available in the market: As much as many companies are traded in fractional shares, there are still some companies whose stocks are not available as fractions. Therefore you may not be able to invest in your favorite company if it happens to be among the ones with such limitations.
- Low market liquidity: Ultimately, shares are traded in the securities markets as wholesome assets. Since brokers split them before selling to investors, they have to wait until enough fractional shares are accumulated before executing their orders in the stock market. This results in low liquidity and means that it might take a longer time to sell your fractional shares than a whole share. In addition, the demand for some fractional shares is relatively low, which may prolong their trades.
- Limited voting rights: Many companies do not recognize fractional shares because they don’t issue their shares as fractions. Therefore, fractional shareholders are mostly barred from any voting rights. This denies such shareholders the right to critical decision-making even when they think the company is heading in the wrong direction.
- Problems in share transfer: In some instances, brokers do not allow the transfer of fractional shares from their platforms to other brokers. In such circumstances, the only solution is to sell the fractional shares and use the money to buy new ones from a different broker. However, this may put you at a disadvantage if the share price appreciates in the intervening time.
- Diminished dividends: As cited above, if you invest in a company that issues dividends, you will receive your dividend in proportion to the number of shares you own. Therefore, if you own a fraction of a share, you will also receive a fraction of dividends. This will deny you the chance to benefit from a profit-making company fully.
Fractional shares are worthy investment assets, and you should consider buying them if they fit your financial goals. They allow easy diversification with little money. However, they have some limitations which may hinder you from enjoying the same rights as those owning full shares.