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How Do Fractional Shares Work?
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How Do Fractional Shares Work?

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More and more often, big name stocks come with big price tags. As of August 2020, one share of Google parent, Alphabet, Inc., was priced at more than $1,500—while one share of Amazon.com, Inc. was above $3,000.

Thankfully, fractional shares let you buy the priciest stocks and exchange traded funds (ETFs) for as little as one dollar. Buying fractional stock is a boon to new investors who might not have huge balances ready to buy certain stocks or ETFs. They also help you easily diversify a smaller portfolio by investing in companies that otherwise might be out of reach.

What Are Fractional Shares?

As their name suggests, fractional shares are portions, slivers, or slices of stocks and ETFs that are smaller than a whole share.

You could purchase fractional shares for any number of reasons: You might not have enough money to buy a full share of a stock, or you might want to invest a set dollar amount in a stock or ETF every month—say $100—rather than try to buy a round number of shares that have a fluctuating stock price, costing say $90 one month and $150 the next.

Fractional shares are a relatively new development in investing—only a few years ago it was almost impossible to buy less than single shares of stocks and ETFs. Mutual funds have long supported fractional share investing, but until recently you could only own fractions of shares in a few limited ways:

  • Stock splits or reverse stock splits. When a company splits its stock, it boosts its share count by giving shareholders additional shares of stock. In a 3:2 stock split, for example, you receive three shares for every two shares you own. So if you owned 15 shares, you would now have 22 ½ shares. That extra half stock is a fractional share. In a 3:2 reverse stock split, you’d end up with two shares for every three you own.
  • Dividend reinvestment plan (DRIP). With a DRIP, dividends paid out by a company or fund are automatically used to purchase new shares. When this happens, investors can end up with fractional stock. Let’s say you owned 200 shares of a company and the annual dividend payout was $0.30 per share. You’d be entitled to dividends worth $60 this year. If the stock is priced at $40, the dividends would automatically buy one and a half shares. You’d end up owning 201 ½ shares of stock.
  • Mergers and acquisitions. When companies merge or are acquired, their stock may be exchanged for new shares. They generally use a ratio to combine stocks from different companies, meaning five shares of Company A might become three share of Company B. This process could result in fractional shares.

How to Buy Fractional Shares

Many online brokerage platforms sell fractional shares, including Fidelity, Charles Schwab and Robinhood. Investing apps such as Stash, Cash App Investing and SoFi Invest also offer fractional shares. A few robo-advisors, like Acorns and Betterment, purchase fractional shares for your portfolio (but not all: Wealthfront holds your money as cash until you have enough to buy whole shares).

Depending on the brokerage, you might need to buy at least $1 or up to $5 worth of fractional stock. In addition, not all stocks or ETFs offered for sale on an investing platform are available as fractional shares. Charles Schwab, for example, only sells fractional shares of companies in the S&P 500, while Stash offers a curated list of stocks and ETFs.

If you want to buy fractional shares, compare online brokerages and investing apps before you sign up to ensure the one you choose allows it. Also, take a look at the list of stocks or ETFs available as fractional shares.

Finally, make sure there aren’t additional commissions or fees for fractional share investing. Since fractional share buys are usually made in smaller dollar amounts, fees could drastically eat into your returns.

Benefits of Fractional Shares

  • Start investing with smaller amounts of money. If you’re just starting out and don’t have a large balance of money to invest, fractional shares can make a big difference. They let you get into the market immediately and start benefiting from compounding returns sooner.
  • Diversify your portfolio with less money. One of the basic rules of portfolio construction is diversification. By owning a variety of different stocks and especially ETFs, you can reduce the likelihood that you lose money if any one stock tanks. Because fractional investing lets you buy many shares for $1 to $5, you may be able to buy broader selections of stocks than you could otherwise.
  • Better dollar cost averaging options. With dollar cost averaging, you invest a set amount of money regularly. Over time, this may let you pay less per share than you would if you bought all of your shares at once. Because dollar cost averaging is focused on a consistent dollar amount, not a consistent share amount, it works better when you’re able to invest that full amount. Otherwise, some of your money has to sit in a cash account before you have enough to buy a full share.

Downsides of Fractional Shares

  • Limited selection of stocks: Not every stock is available for fractional investing. You might not be able to choose from as many companies as you could if you bought whole shares.
  • Liquidity: You might not have immediate asset liquidity with your fractional shares. Fractional shares may not trade as frequently or as rapidly as whole shares. Brokers wait to accumulate enough fractional orders to buy whole shares, which may reduce the speed of filling orders. Also, not every fractional share is in high demand, so it can sometimes take longer to buy or sell your fractional shares.
  • Shareholder rights: Depending on your broker, you may not be able to exercise voting rights on company matters if you own less than a whole share. Robinhood, for example, adds up fractional shares into whole shares to report votes to companies. Stash, on the other hand, doesn’t let you vote on company issues until you have at least one share of a company.
  • Transfers: Some brokers won’t let you transfer fractional shares to other brokers. Instead, they transfer any full shares and sell any fractional shares to give you as cash. This may be merely an inconvenience, as you may be able to repurchase shares quickly at your new brokerage. That said, liquidating fractional shares may have unintended tax consequences if your fractional shares have increased in value.
  • Dividends: Just as fractional stocks represent a portion of a full share, if you own fractional shares, you’ll get the portions of stocks’ dividends. So, if a payout is $0.50 per share, and you have half of a share, you’ll receive $0.25 as a payout.

Before purchasing fractional shares, make sure you understand your brokerage’s fractional share policies and fully understand the pros and cons of buying portions of shares.

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