With buy-ins so high for some stocks, how can the average person ever hope to invest?
When first setting off to invest in the stock market, an investor might be struck by the seeming barriers to entry. One such barrier can be cost—the perception that thousands of dollars may be needed to get started.
Enter fractional shares. But what is a fractional share? Can you really buy fractions of shares? And are fractional shares worth it?
Instead of purchasing one share of stock at the value for which the stock is currently trading, it is possible to purchase a fraction of one share of a stock. And an investor can do so using whatever dollar amount they have available.
Fractional shares of a stock are also known as fractional equity shares or partial shares, and there are advantages and disadvantages to this type of investing.
A Quick Overview of Stocks
To understand how fractional shares work, it helps to know how a stock works. When an investor buys a share of a company’s stock, they are buying ownership in that publicly-traded company.
This is why stocks are also called equities, because investors own equity in that company. Stocks are sold in parcels called “shares,” and owners are often referred to as shareholders.
Therefore, a fractional share is some fraction—or portion—of one share of a stock.
The value of the company is not necessarily represented by a stock’s price per share. Instead, the value of one share of stock is a byproduct of how many shares that the company has made available for public purchase—called “shares outstanding.”
To find the size of a company as valued by the market, also known as the company’s “market capitalization,” multiply the shares outstanding by the per-share stock price.
For example, just because Company A has a per-share stock price of $100, it is not necessarily a bigger (or better) company than Company B which sells for $10.
If Company A has 10,000 shares outstanding and Company B has 1,000,000 shares outstanding, their market capitalizations are $1,000,000 and $10,000,000, respectively. Company B is more than 10 times the size of Company A.
Stocks are bought and sold on an exchange, like the New York Stock Exchange or the NASDAQ. One common way to buy and sell stocks trading on an open exchange is through brokerage accounts. An investor can open up an account at a brokerage house and place stock trades within their portfolio.
Typically, there is a trading commission involved in buying and selling stock shares.
Historically, investors buying stocks through brokerage firms have been unable to buy less than one share of stock. This might make it difficult for some investors to buy stocks out of their price ranges. That’s where fractional shares can make higher priced stocks more accessible.
Can You Buy Half a Stock?
The simple answer is that yes, you can buy half a stock if you’re using fractional shares to invest. With fractional shares, it’s possible to buy stock without having to purchase the entire share. Instead, you use whatever dollar amount you have available to build a portfolio.
For example, a beginning investor might have $500 to purchase shares of stock. But the stock they want to buy is trading at $1,000 per share, putting it out of reach. Thanks to fractional shares, they could still invest the $500 by purchasing half of a single share. Then, once they have another $500 to invest, they could purchase another half share, which would allow them to own one full share altogether.
Fractional shares allow investors to purchase stocks in increments that fit their financial situation. So for instance, it’s possible to buy half of a stock but you could also use fractional investing to purchase one-quarter or one-third of a stock. This type of strategy is also known as dollar-based investing, since it’s based on the amount of money someone has to invest, rather than an investment’s purchase price.
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Advantages of Buying Fractional Shares
Investing money this way can offer some benefits, but are fractional shares worth it? They can be if they help to further your overall investment strategy and goals.
The primary advantage of buying a fractional share is that investors are able to buy part of a stock that may otherwise be too expensive. In this way, fractional shares dismantle a large barrier to entry for those who want to invest.
Fractional share investing can also give young or new investors access to stock markets so that they can learn about them and investing firsthand.
For some, this hands-on approach to learning may be a more effective form of education than thinking about investment ideas or concepts in theory.
The investor controls precisely how much money they want to spend on a stock. Fractional shares allow an investor to build their portfolio even without having a significant chunk of change to invest.
And this could potentially allow their money to participate in the stock market for a longer period of time. Additionally, it can help investors buy the stocks that they actually want to hold in their portfolios, not just the ones that they can afford. Fractional shares can give the investor more control over their portfolio, allowing them to build out a strategy using the desired amounts of each stock. Because ultimately, it’s probably the dollar value of each investment that’s important to the investor’s strategy, not the stock’s price per share.
Because an investor can buy a variety of stocks using the money they have available, it may be easier to help in building a more diversified portfolio. Diversification, the idea that investors can mitigate some risk in their portfolios, is generally achieved by buying a variety of investments.
With more control over how much of each stock they can buy, investors could potentially construct a portfolio that is diversified to their liking.
Disadvantages of Buying Fractional Shares
Here are some of the potential downsides and risks from trading fractional shares.
While investors can, indeed, buy fractional shares, unfortunately, traditional brokerage firms might not offer them for sale. They may also place restrictions on selling fractional shares, since they have to be joined with other fractional shares to create a whole share in order to be sold.
And then, those same institutions may charge a flat transaction fee to buy or sell a stock, no matter how few shares the investor plans to trade. Whether buying whole or fractional shares, trading fees and account fees can have an erosive effect on an investor’s returns.
Some brokerage firms charge every time an investor buys or sells a stock. That means that an investor would pay the trading commission whether they were buying a quarter of one share or 500 shares of a stock.
A fee of a few dollars to purchase a whole or fractional share may not seem like a lot, but it can be to an investor without a lot of capital to get started. This is especially true if the investor is interested in building out a diversified portfolio of holdings, since buying 10 stocks could mean paying the fee 10 times.
How Different Institutions Can Handle Fractional Shares
The good news here is that not every financial institution charges a transaction fee. SoFi Fractional Shares allows for the purchase of partial stocks at no additional cost to the investor. So, that’s a win.
While some brokerage firms don’t allow the purchase of fractional shares, they may still end up in customer accounts for reasons discussed below. Each brokerage firm has a different strategy for handling partial shares. Sometimes, brokerage firms have policies in place to pay out cash when a customer acquires a fractional share.
Other brokerage firms may charge a higher transaction fee to sell partial shares received from dividend reinvestment and may only allow shareholders to sell partial shares if they sell all their shares of that particular stock.
Where Do Fractional Shares Come From?
To buy fractional shares, it helps to understand how and why they exist. Often, a fractional share is the result of a stock split, company merger or acquisition, or dividend reinvestment plan (called a DRIP).
In order to lower its price per share, a company may initiate what is called a “stock split.” A stock split may not always result in an even number of shares.
For example, in a 3-for-2 stock split, a company provides a third share for every two owned by an investor. If the investor initially holds 125 shares, they will own 187.5 shares after the stock split.
The investor still owns the same amount of stock in dollars, because the value of those shares will simultaneously drop by one-third. Sometimes, the company will just transfer you cash in exchange for any fractional shares remaining so you don’t have to worry about it.
Company Merger & Acquisition
A company merger or acquisition may also result in the creation of fractional shares. When one company acquires another, they may offer their shareholders the option for a stock merger (as opposed to cash merger). With a stock merger, investors will receive a “conversion ratio,” which is the ratio that converts the shares of the company being acquired.
Do Fractional Shares Pay Dividends?
Some, though not all, stocks pay dividends to investors. These dividends , which can be paid monthly, quarterly or annually, represent a percentage of the company’s profits that are then paid out to shareholders.
If you purchase shares of dividend-paying stocks fractionally, then you can receive dividend payouts from those stocks just the same as you would if you purchased full shares. The dividend payout you receive would be proportionate to your ownership stake in the stock. So, say you own a half a share of a stock that pays out a $4 dividend per share to its investors. You’d be able to collect half of that dividend payment or $2.
Dividend Reinvestment Plans or DRIPs can also produce fractional shares. Companies can offer DRIPs to investors as a way to reinvest in that company’s dividend-paying stock. When a stock pays out a cash dividend to its shareholders, the DRIP reinvests the money back into the stock automatically, even if the amount of the dividend isn’t enough to purchase an entire share. DRIPs are a popular option because they don’t often have trading commissions or other brokerage fees.
Cash in Lieu of Fractional Shares
It’s possible that you may be offered cash in place of fractional shares in certain situations. Instead of crediting you with additional fractional shares, the company you’ve invested with would sell those shares. They’d then send you a check representing the amount of cash resulting from the sale.
A cash in lieu situation can happen when a company undergoes a major transition, such as a merger or acquisition. They can also occur when there’s a stock split. It can be easier for companies to simply sell fractional shares and pay investors cash for them, versus creating new fractional shares.
If you receive cash in lieu of fractional shares, you should also receive a Form 1099-B from the company showing how much was paid to you. You’d need to include this form when filing your taxes since the IRS requires investors to account for these payments.
Where to Buy Fractional Shares
If you’re interested in purchasing fractional shares, you have a few options for doing so, starting with DRIPs. The problem, however, is that while some companies may offer DRIPs to new investors, it’s more common for this purchase option to be offered to existing shareholders only. If a company does offer a DRIP to new investors, the purchase typically has to be done through a third-party administrator..
Another option is to buy fractional shares using a mutual fund. Though a mutual fund is not a stock, it could be a fund that holds many stocks. Some mutual funds might allow for the purchase of fractional shares.
For instance, there are options for brokerage firms that allow investors to purchase mutual funds using dollar amounts. An investor could get started buying a fractional share in a small amount while achieving diversification through owning the many stocks that are held in one fund.
An avenue may be to invest in fractional shares through an online investment platform. SoFi Invest® has an Active Investing platform that lets investors choose from an array of stocks, ETFs or fractional shares. For a limited time, opening an account gives you the opportunity to win up to $1,000 in the stock of your choice. All you have to do is sign up, play the claw game, and find out how much you won.
Stock Bits is a brand name of the fractional trading program offered by SoFi Securities LLC. When making a fractional trade, you are granting SoFi Securities discretion to determine the time and price of the trade. Fractional trades will be executed in our next trading window, which may be several hours or days after placing an order. The execution price may be higher or lower than it was at the time the order was placed.
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