Understanding Fractional Shares: A Guide for Beginner Investors
In southern New Jersey, a battle heats up every summer on the boardwalk in Wildwood. It’s not a battle over politics or sports but something far more relatable and crucial to everyday life — pizza. The battle is Sam’s vs Mack’s and everyone has an opinion over which is better.
The big selling point for both shops is that you can buy a single slice while walking down the boardwalk and then continue on your way. Now imagine you couldn’t just buy a single slice but instead had to buy an entire pie to get pizza. What do you do if you’re by yourself and don’t want eight slices? And why would you pay for a full pie when you really only wanted a slice or two?
Many new investors run into a similar problem when they begin building a portfolio. Stocks can be purchased in increments as small as one share, so the prevailing wisdom is to think of a share as a slice of the company’s pie or equity. But then look at a company like Amazon or Google — a single slice of that pie will cost over $2,500.
Let's re-imagine each share as a pie. That share can be cut up and Distributed to investors who wish to build a diversified portfolio but can’t afford to fill it with individual shares of Amazon, Google or other four-digit-priced stocks. If that sounds like a good idea to you, you’ll be happy to know it already takes place at many brokerages.
Fractional shares allow capital-light investors to assemble diverse portfolios without needing to add leverage, borrowed money or an investment vehicle like an Exchange-traded fund (ETF) or mutual fund.
Overview of Fractional Shares
A fractional share is a small piece of a share sold to investors who cannot afford to buy a full share. A fractional share isn’t purchased by entering the number of shares you want in a traditional buy or sell order. Instead, you enter the dollar amount you wish to spend on a certain stock and own the equivalent share fractions of that dollar amount.
For example, if you wanted to buy 10 shares of Amazon, you’d need about $1,820 to complete the order since each Amazon share is over $182 in October 2024. But if you wanted to buy $1,000 worth of Amazon, you’d purchase 0.5 shares from a broker offering fractional shares.
Where do fractional shares come from? If you have a retirement plan with an automatic dividend reinvestment option, you likely have purchased fractional shares already. Fractional shares can also be created from stock splits, mergers and acquisitions or capital gains distributions. Today, many brokers allow clients to purchase partial shares directly.
Why Invest in Fractional Shares
The main reason investors purchase fractional shares is that they have limited capital and wish to build a diversified portfolio without resorting to ETFs or mutual funds. When buying ETFs, you rely on the decisions the index or fund manager as far as holdings. And mutual funds are the same way, minus the advantageous Tax structure. Buying fractional shares allows someone to own multiple individual stocks in various sectors without a five-digit sum of capital.
For example, if you have $4,000 to invest, you could have to choose between Amazon and Google if your minimum buy was one share. But with fractional shares, you can buy $2,000 worth of each company. Or $1,000 of each, plus a few full shares of Apple or Meta Platforms. You can buy or sell these shares when it suits your investment plan as well.
Another advantage of fractional shares? Dollar-cost averaging. You can invest the same amount in your brokerage account each month, week or day with fractional shares. Dollar-cost averaging is a proven strategy because investors capture upside by investing consistently in downturns while also limiting declines with periodic rebalancing. Buying low and selling high sounds easy in theory, but people tend to get emotional when money is involved. Dollar-cost averaging creates a plan that investors can stick to.
Disadvantages of Fractional Shares
Fractional shares have some downsides as well. For starters, you’ll need to make sure you aren’t killing your account with a thousand papercuts. If fractional share purchases come with commission, you’ll need to be cautious not to rack up trading fees.
Stock selection can also be a concern. Some brokers may have a diverse group of fractional share offerings, but there’s no guarantee the particular stock you want will be there. Additionally, transferring fractional shares from one broker to another is often a headache-inducing process so pick a broker you like.
But the biggest issue with fractional shares is liquidity. Finding a counterparty to buy and sell fractional shares to is more difficult than whole share orders. A lack of liquidity could mean holding shares longer than you previously anticipated and accepting declines beyond your pre-planned limits.
Where to Buy Fractional Shares
With more investors participating in the stock Market thanks to commission-free online brokers and the popularity of meme stock investing, fractional shares are highly sought after. Brokers offering fractional shares include Cash App, SoFi Invest, E*TRADE and Cash. Be sure to check with your particular broker of choice for stock availability and ask plenty of questions about fees and commissions.
Democratizing Investing
“Democratize investing” is a phrase thrown around by brokers like Robinhood who want to get new investors into the fray. Most of the time, it’s used as a marketing slogan to get new signups but adding fractional shares and selling them commission-free is a way to let new investors build diverse portfolios without requiring a mountain of money to start.
Buying index funds in a 401(k) is a sound retirement strategy, but many young people would like to build stock portfolios in taxable accounts and don’t have the funds to diversify. Fractional shares put diversification in reach for everyone, regardless of income. Just be sure to understand the additional risks that come with partial shares.
Frequently Asked Questions
- Q: If I buy fractional shares and there’s a stock split, do I still benefit?
- Q: Can I buy ETFs as fractional shares?
- Q: Are fractional share rules the same across all brokers?
A: If you buy fractional shares and later there’s a stock split, you still benefit from the split. Your brokerage account will automatically adjust the number of shares you own after the split, ensuring that you maintain the same proportion of Ownership.
A: Yes, many brokerage firms offer the option to purchase fractional shares of ETFs, allowing investors to buy a portion of a share instead of a whole share. This can provide more flexibility and accessibility to a wider range of investors.
A: No, each broker may have their own specific rules regarding fractional shares. It is important for investors to research and understand the fractional share rules of their chosen broker before engaging in fractional trading.
