Fractional Shares: Should You Invest In Them?

Nov 12, 2020 08:34 PM ET
Fractional Shares: Should You Invest In Them?

Over the last few years, fractional shares have gained steam and have become a crucial part of investment management and investing industries. But, not everyone is aware of them and how they can benefit from them. Let’s take a look at these unique share types, how they come into existence, and why they are a beginner investor’s dream. 

What are fractional shares?

These constitute less than one complete share of the equity. Even though they cannot be accessed in the stock market and are harder to sell, they have a lot of value for investors. These enable small players to invest a little in securities that they wouldn’t have been able to if shares were not divisible as such.  What this does is it opens up new opportunities for investors and enables them to keep their portfolio well-diversified even if they don’t have a lot of capital. 

What are fractional shares?

It would be hard for beginner investors to get into the market with very little risk. They also wouldn’t be able to build up their portfolio and take stock in companies, the shares of which may cost them north of a few thousand bucks. It has made it convenient for investors of all types to take stock in companies they favor. Of course, no voting rights are endowed on such shares. 

How are fractional shares made?

Such shares are formed through different activities on the part of the corporations. Let’s take a look at what they may be.

Mergers and Acquisitions

Companies bring together stocks using a set-ratio that is determined from the start, thereby ending up with fractionated shares. For instance, if you have 6 shares of company A that is being merged with or acquired by company B that is changing the shares 1-for-4 in the new entity, you would be left with 1.5.

fractional shares 

Stock splits

Unlike the previous type, the shares in this type don’t even end up with an even number. For instance, if a company declares a 5-for-2 split, someone owning the shares will be given five shares for every two that they own. Going by the same basis, anyone owning odd-numbered shares will be left with some fraction upon splitting. So, if they had three, they will now have seven and a half; if five, then twelve and a half. 

Dividend reinvestment plans

Such plans often produce fractioned shares as well. This tends to occur when the entity providing investors with a dividend facilitates the use of returns to buy the same share again. Sometimes, the dividend may not be sufficient to get the whole share, which results in fractioning it. 

Occasionally, several firms will deliberately break up shares for purposes of selling them. That habitually tends to be the case with companies that have expensive stocks, such as those of Amazon and Google.

Dividend reinvestment plans

Why should you opt for fractional shares?

For those who are just beginning with their investments and those who have some additional capital to park somewhere where it is guaranteed to grow in the long term, such as in companies mentioned above, fractional shares can come in handy. 

One needs only to get a small slice of the share in order for the capital to start growing. The important thing to consider here is that one doesn’t have to wait to have sufficient capital to diversify one’s portfolio. Simply divvy up your funds and park them in companies you prefer. 

Sure, the money may not be enough in the beginning, but over time the magic of compounded returns snowballs into something much bigger than you could even imagine. On top of that, it is also easy to buy such shares because then you’re not worrying about the amount that you need and can rather think about what you can get with the money that you do have. 

These shares have kindled an interest in investing and brought in many more people in the market. This has automatically led to companies being governed better, which, in turn, solidifies higher returns. 

The requirements aren’t as stringent either. One needs a funded brokerage account, that’s all. However, the idea of such shares hasn’t taken on too much in markets outside of the U.S. That is why you may not find such an option in the European or Japanese markets. It mainly boils down to what your brokers provide. Yet, the basic idea is catching on steadily, and the option to do so is being assimilated slowly. Most big brokerage firms do, however, provide this option.

Cons of fractional shares

Of course, if a thing is new and becoming popular fast, there are bound to be some disadvantages that may or may not be in investors’ hands. Let’s take a look at some of them:

  • Beginning investors can be quite foolhardy with their returns. 

  • Higher investing in a company may inflate the share prices. Such inflated stocks seldom make for good investments. Just the price being high doesn’t mean it is a dependable investment. 

  • If your fraction is too small, all your dividends may end up with the broker. 

  • The higher investment in various companies can also drive up the fees charged by your broker. The commission may again get higher with the temptation to keep investing more. 

Final Word

Fractional shares have opened up the market to low-capital investors as well. This has been possible due in no small part to the technical advancements of our age. The growing interest means that the market will become more democratic, while the emergence of a new investor class means that the returns will also become consistent. This trend is not looking to die down any time soon with additional technological improvements coming up.

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