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Fractional shares allow investors to invest in stocks and exchange-traded funds based on how much they want to invest instead of on the price of the company's or fund's shares. While fractional shares have been around since the late 1990s, they've become popular only recently.
Fractional shares can make investing more accessible, but it's important to understand how buying them can impact your finances.
How Do Fractional Shares Work?
A fractional share is essentially a slice of a company's stock or an exchange-traded fund (ETF). For example, let's say you want to invest in Apple stock but the price of one share is $135 and you only have $75. In this scenario, you can purchase 0.56 shares of Apple with the money you have.
Fractional shares participate in both gains and losses just like normal shares, but in terms of real dollars, the impact is less.
If Apple stock jumps 10%, for instance, someone who owns a full share will see their position grow to $148.50, a jump of $13.50. If you only have $75 worth of the stock, you'll still get a 10% return, but the dollar value will be $7.50, bumping your position to $82.50.
In addition to purchasing a fraction of a share or ETF, there are other ways to get fractional shares:
- Dividend reinvestment plans: Called DRIPs for short, these plans allow you to reinvest dividends you earn on your stocks to buy fractional shares instead of taking the dividends as cash.
- Mergers and acquisitions: When one company acquires another, the common stock of each company is often combined at a certain ratio. The math doesn't always work out to give shareholders an even number of shares, though, resulting in fractional shares.
- Stock splits: A stock split occurs when a company increases its number of shares, which, in turn, decreases the value of each individual share. For example, if you have three shares of Apple stock with a $150 share price and the company does a 4-to-1 split, you'll now have 12 shares at a price of $37.50 per share. But as with mergers and acquisitions, the math doesn't always work out to give an even number of shares, so you may end up with fractional ownership.
What Are the Benefits of Fractional Shares?
Fractional shares have become increasingly popular among brokers and investors, and there are good reasons for it:
- They help level the playing field. Fractional shares have created opportunities for many people who were unable to invest in the past. They allow beginners and even experienced investors to purchase ownership in companies they wouldn't otherwise be able to invest in because of a high stock price.
- They offer increased diversification. When you don't have a big investment account balance, it can be difficult to diversify your stocks without purchasing an index fund. But with fractional shares, you have more power to diversify because you're investing in companies based on a dollar value instead of the number of shares.
- It makes it easier to dollar cost average. Dollar cost averaging is an investment strategy in which you invest the same dollar amount at regular intervals regardless of how a stock or fund is performing. Because fractional shares are based on dollar amounts, they're perfect for this approach.
Who Offers Fractional Shares?
Several brokers allow investors to invest in stocks, ETFs or both via fractional shares. Here's a list of some popular options:
- M1 Finance
- Charles Schwab
- Interactive Brokers
In most cases, you can buy fractional shares with as little as $1, but Stash and Charles Schwab both have a $5 minimum. Also, Charles Schwab is the only one that doesn't allow you to purchase fractional shares in ETFs.
What to Know Before You Invest in Fractional Shares
Fractional shares make it easier for more people to invest in the companies they like. But they also make it easier to justify trading recklessly, especially among new investors who don't yet have a settled investment strategy.
As a result, it's crucial that you take some time to learn about the risks that come with investing generally and try to develop a strategy for how you want to approach trading.
Also, some brokers still charge commissions every time you trade, and because people are often buying fractional shares because they have less money, these fees may represent a large percentage of your portfolio value.
Before you open a brokerage account, shop around and compare several options to find out which ones charge trading fees, the types of fractional shares they offer and how to manage your risks well.
Build a Financial Foundation Before You Start to Invest
Investing may sound more exciting than budgeting and saving, but because of the risks involved with the stock market, it's critical that you establish a solid foundation for your finances.
This doesn't mean you can't invest at all until you've mastered other areas of your finances. But resist the urge to pour all of your money into fractional shares to try to maximize your gains. If the stock market experiences a downturn, you could end up losing money that you actually need to get by.