It is not rare for big name stocks to come with big price tags. As a result, not everyone can afford to buy the companies they like. Fractional share are portion of an stock or ETF, making the purchase of expensive stocks for individual investors with a low capital.
- A fractional share is a portion of an equity that is less than one entire share of the stock or ETF.
- Fractional shares can be intentionally offered by brokerage to ease investment costs for some products.
- Fractional shares can also be by-products of events on the market, such as dividend reinvestment plans, stock splits or mergers and acquisitions.
- Fractional shares can be good because it allows investors to invest in products that might otherwise be too expensive.
- Fractional shares also have their drawbacks, as they need to be reunited into whole shares before being sold back on financial markets.
What are fractional shares?
Fractional shares are pieces of one full share of a company or exchanged-traded fund (ETF). While these can be unintentionally created by movements in the market as explained in the next sections, some brokerages offer the possibility to buy a percentage of a share instead of buying entire shares. Say that the shares of Amazon is worth $2,500. Instead of buying the entire share, an investor might want to invest only $25 in the company, thus owning 1% of an Amazon share.
In the case of dividend stocks, distributed dividends will be allocated respectively to the percentage you own of a share. If company XYZ offers a $2 dividend and you own half of its stock, you will receive $1.
How can fractional shares be created?
Fractional shares can come to be created in a number of ways, including the following:
- Dividend Reinvestment plans: when a brokerage firm allows investors to use dividend payouts to purchase more of the same shares, this is called a dividend reinvestment plan. Most times, the money from dividends is not the exact amount to buy whole shares and often results in the acquisition of fractional shares.
- Stock splits: when companies decide to split their stocks, these do not always results in even numbers of shares. If we take the example of a 3 for 2 split, three shares would be created for every 2 shares owned by an investor. The investor who owns an uneven number of shares will end up with a fractional share in his portfolio.
- Mergers and acquisition: when two companies merge, the new common stock created to replace the two previously separate stocks combines them with a predetermined ratio. This also leads to the creation of fractional shares.
- Brokerage firms intentionally splitting shares: some brokerage firms will intentionally split shares to make them easier to trade for their clients. In the case of high-priced stocks that can be worth hundreds our thousands of dollars, the possibility to buy fractional shares can be one of the only ways for individual investors to take part.
What are the advantages of a fractional share and why would I buy one?
Say you are looking to pick up investing, but you only have a limited amount to play with in the beginning, like $1,000. Suppose that you really like the services offered by Google-owner Alphabet Group. You are a true believer in services like YouTube, Maps, and confident that the company has a bright future ahead. So why not invest?
Your only issue is that the Alphabet stock is currently trading at over $2,100, making it impossible for you to acquire a share, even with your entire budget – which would also be a great risk, as this would be neglecting diversification.
Fortunately, with fractional shares, you have the option to invest in the company without needing to put in the money necessary to buy an entire share. Therefore, this split made by FlowBank helps you acquiring stocks your really care about, without being limited by the size of your portfolio. You now have the possibility to build a diversified portfolio, even with a smaller starting capital.
What are the downsides of fractional shares?
Fractional shares are not bought and sold on traditional exchanges, and the only way to trade them is through a major brokerage firm, which does the job of putting them together and selling them one major exchange once the fractions make a whole. This process can sometimes take long if the stock does not have a high demand in the marketplace.
Additionally, not all stocks are available as fractional stocks. The range of choice might not be as cast as if you were to buy entire shares.
Finally, fractional shares cannot always be transferred to other brokers. Fractional shares owner often have to sell back their assets in exchange for cash. Although this is technically not an issue, it can add fees and taxes to pay.