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 thousands of dollars may be needed to get started.
Enter fractional shares. But what is a fractional share? And can you buy fractions of shares?
Yes, 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 houses. 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.
With fractional shares, investors can buy stock without having to purchase the entire share. Instead, the investor uses whatever dollar amount they have to invest. For example, someone with $200 to invest, but wants to buy a stock trading at $1,000, could simply invest the $200, buying a 0.2 fractional share.
Win up to $1,000 in free
Advantages of Buying Fractional Shares
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 but who aren’t sitting atop some Scrooge McDuck pile of riches.
Instead, 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.
Buying fractional shares using a dollar amount may feel familiar to those who have invested in mutual funds. Because mutual funds don’t trade on an exchange as a stock does, and you generally buy and redeem shares from the fund itself, fractional fund shares are made available to investors.
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.
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.
Disadvantages of Buying 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.
The good news here is that not every financial institution charges a transaction fee. SoFi Stock Bits allows for the purchase fractional shares 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 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.
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.
DRIPs also produce fractional shares. Companies 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, 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.
Buying Fractional Shares
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 “>third-party administrator DRIP makes for a cute acronym, as cash from dividend payouts is “dripped” back into the stock. It may also be possible to add additional contributions via a monthly contribution.
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, and mutual funds might allow for the purchase of fractional shares.
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.
Companies looking to shake up the traditional brokerage universe might also offer fractional shares, knowing that such an offering helps new investors get off the ground. One such example is SoFi Invest® Stock Bits, which makes it possible to own part of a stock from your favorite company without committing to a whole share.
With SoFi, there are no account or trade minimums, which means that investors of any income bracket or investing background can use a SoFi Invest® account to buy fractional shares.
Start investing with as little as $1. For those looking for fractional share investing, there’s hardly a better opportunity out there.
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