Are Fractional Shares Worth Buying?

Fractional shares are a useful way to allow new investors to get their feet wet by investing small amounts of money into parts of a share of stock. For some investors, fractional shares are worth it because it means they can own a part of a stock from a company they are interested in, without committing to buying a whole share.

While fractional shares have much in common with whole shares, they don’t trade on the open market as a standalone product. Because of that, fractional shares must be sold through a major brokerage.

What Does It Mean to Buy Fractional Shares?

A fractional share is less than one whole equity share (e.g. 0.34 shares). Fractional shares appreciate or depreciate at the same rate as whole shares, and distribute dividends at the same yield proportionate to the fractional amount.

Fractional shares were previously only available to institutional investors at one-sixteenth intervals, but have recently become widely available to retail investors at exact decimals (in order to increase market pricing precision and lower trading costs).

This new capability offers another layer of financial inclusion to casual investors by lowering minimum investing requirements to thousands of stocks and assets and making them available in smaller quantities.

Why Fractional Shares Are Worth Buying

For some investors, these positives make buying fractional shares worth it.

Access to Unaffordable Stocks

Fractional shares can help build a portfolio made of select stocks, some of which may be too expensive for some investors to afford one whole share. With fractional shares, an investor can choose stocks based on more than just price per share.

Previously, new investors would face price discrimination for not having enough funds to buy one whole share. But with fractional shares, an investor with $1,000 to spend who wants to buy a stock that costs $2,000 per share, can buy 0.5 shares of that stock.

Fractional shares make it easier to spread a modest investment amount across a variety of stocks. Over time, it may be possible to buy more of each stock to total one or more whole shares. In the meantime, buying a fractional share allows an investor to immediately benefit from a stock’s gain, begin the countdown to qualify for long-term capital gains (if applicable), and receive dividends.

A Doorway to Investing

History has shown that the stock market typically outperforms fixed-income assets and interest-bearing savings accounts by a wide margin. If equities continue to provide returns comparable to the long-term average of around 7%, even a small investment can outperform money market savings accounts, which typically yield 1-2%. (Though as always, it’s important to remember that past performance does not guarantee future success.)

By utilizing fractional shares, beginners can make small investments in the stock market with significantly more growth potential even with average market returns versus savings accounts that typically don’t even match inflation.

Maximized Dollar-Cost Averaging

Fractional shares help maximize dollar-cost averaging, in which investors invest a fixed amount of money at regular intervals.

Because stock shares trade at precise amounts down to the second decimal, it’s rare for flat investment amounts to buy perfectly-even amounts of shares. With fractional shares, the full investment amount can be invested down to the last cent.

For example, if an investor contributes $500 monthly to a mutual fund with shares each worth $30, they would receive 16.66 shares. This process then repeats next month and the same investment amount is used to purchase the maximum number of shares, with both new and old fractional shares pooled together to form a whole share whenever possible.

Maximized Dividend Reinvestment Plans

This same scenario applies to dividend reinvestment plans (also known as DRIP investing). In smaller dividend investment accounts, initial dividends received may be too small to afford one whole share. With fractional shares, the marginal dividend amount can be reinvested no matter how small the amount.

Fractional shares can be an important component in a dividend reinvestment strategy because of the power of compounding. If an investor automatically invests $500 per month at $30 per share but can’t buy fractional shares, only $480 of $500 can be invested that month, forfeiting the opportunity to buy 0.66 shares. While this doesn’t seem like much, not investing that extra $20 every month can diminish both investment gains and dividends over time.

Stock Splits

Stock splits occur when a company reduces its stock price by proportionately issuing more shares to shareholders at a reduced price. This process doesn’t affect the total value of an investment in the stock, but rather how the value is calculated.

For some investors, a stock split may cause a split of existing shares, resulting in fractional shares. For example, if an investor owns 11 shares of a company stock worth $30 and that company undergoes a two-for-three stock split, the 15 shares would increase to 22.5 but each share’s price would decrease from $30 to $20. In this scenario, the stock split results in the same total of $450 but generates a fractional share.

Mergers or Acquisitions

If two (or more) companies merge, they often combine stocks using a predetermined ratio that may produce fractional shares. This ratio can be imprecise and generate fractional shares depending on how many shares a shareholder owns. Alternatively, shareholders are sometimes given the option of receiving cash in lieu of fractional shares following an impending stock split, merger, or acquisition.

Disadvantages of Buying Fractional Shares

Fractional shares can be a useful asset if permitted, but depending on where you buy them could have major implications on their value.

Order Type Limitations

Full stock shares are typically enabled for a variety of order types to accommodate different types of trading requests. However, depending on the brokerage, fractional shares can be limited to basic order types, such as market buys and sells. This prevents an investor from setting limit orders to trigger at certain price conditions and from executing trades outside of regular market hours.

Transferability

Not all brokerages allow fractional shares to be transferred in or out, making it difficult to consolidate investment accounts without losing the principal investment or market gains from fractional shares. This can also force an investor to hold a position they no longer desire, or sell at an undesirable price to consolidate funds.

Liquidity

If the selling stock doesn’t have much demand in the market, selling fractional shares might take longer than hoped or come at a less advantageous price due to a wider spread. It may also be possible to come across a stock with full shares that are liquid but fractional shares that are not, providing difficulty in executing trades let alone at close to market price.

Commissions

Brokerages that charge trading commissions may charge a flat fee per trade, regardless of share price or quantity of shares traded. This can be disadvantageous for someone who can only afford to buy fractional shares, as they’re being charged the same fee as someone who can buy whole or even multiple shares. Over time, these trading fees can add up and siphon limited capital that could otherwise be used to buy additional fractional shares.

Higher transaction fees

Worse yet, some brokerages may even charge higher transaction fees for processing fractional shares, further increasing investor overhead despite investing smaller amounts.

What Happens to Fractional Shares When You Sell?

As with most brokerages that allow fractional shares, fractional shares can either be sold individually or with other shares of the same asset. Capital gains or losses are then calculated based on the buy and sell prices proportionate to the fractional share.

The Takeaway

Fractional shares are an innovative market concept recently made available to investors. They allow investors of all experience and income levels access to the broader stock market – making it worth buying fractional shares for many investors.

Fractional shares have many other benefits as well — including the potential to maximize both DRIP and dollar-cost averaging. Still, as always, it makes sense to pay attention to downsides as well, such as fees disproportionate to the investment, and order limitations.

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