What Are Fractional Shares?

Fri Jun 11, 2021, 05:32 pm | by Dan Schmidt | No comments

In southern New Jersey, a battle heats up every summer on the boardwalk in Wildwood. It’s not a battle over politics or sports, but something far more relatable and crucial to everyday life – pizza. The battle is Sam’s vs Mack’s and everyone has an opinion over which is better (it’s Mack, just FYI). 

The big selling point for both shops is that you can simply buy a single slice while walking down the boardwalk and then continue on your way. Now imagine you couldn’t just buy a single slice, but instead had to buy an entire pie to get pizza. What do you do if you’re by yourself and don’t want 8 slices? And why would you pay for a full pie when you really only wanted a slice or two?

Many new investors run into a similar problem when they begin building a portfolio. Stocks can be purchased in increments as small as one share, so the prevailing wisdom is to think of a share as a slice of the company’s pie (or equity). But then look at a company like Amazon (NYSE: AMZN) or Google (NYSE: GOOG) – a single slice of that pie will cost over $2500. 

Now, what if we re-imagined each share as a pie itself. That share can then be cut up and distributed to investors who wish to build a diversified portfolio but can’t afford to fill it with individual shares of Amazon, Google, or other four-digit priced stocks. If that sounds like a good idea to you, you should be happy to know it already takes place at many brokerages.

Fractional shares allow capital-light investors to assemble diverse portfolios without needing to add leverage, borrowed money, or an investment vehicle like an ETF or mutual fund.

Overview of Fractional Shares

A fractional share is simply a small piece of a share sold to investors who cannot afford to buy fully-priced shares. A fractional share isn’t purchased by entering the number of shares you want in a traditional buy or sell order. Instead, you enter the dollar amount you wish to spend on a certain stock and own the equivalent share fractions of that amount. 

For example, if you wanted to buy 10 shares of Amazon, you’d need about $33,000 to complete the order since each Amazon share is over $3,300 at the time of this writing. But if you wanted to buy $1000 worth of Amazon, you’d purchase 0.3 shares from a broker offering fractional shares.

Where do fractional shares come from? If you have a retirement plan with an automatic dividend reinvestment option, you likely have purchased fractional shares already. Fractional shares can also be created from stock splits, mergers and acquisitions, or capital gains distributions. Today, many brokers allow clients to purchase these partial shares directly.

Why Invest in Fractional Shares

The main reason investors purchase fractional shares is that they have limited capital and wish to build a diversified portfolio without resorting to ETFs or mutual funds. When buying ETFs, you’re at the whim of the index or fund manager as far as holdings. And mutual funds are the same way, minus the advantageous tax structure. Buying fractional shares allows someone to own multiple individual stocks in various sectors without a five-digit sum of capital.

For example, if you have $4000 to invest, you could have to choose between Amazon and Google if your minimum buy was one share. But with fractional shares, you can buy $2000 worth of each company. Or $1000 of each, plus a few full shares of Apple (NYSE: AAPL) or Facebook (NYSE: FB). You can buy or sell these shares when it suits your investment plan as well.

Another advantage of fractional shares? Dollar-cost averaging. You can invest the same amount in your account each month, week, or even day with fractional shares. Dollar-cost averaging is a proven strategy because investors capture upside by investing consistently in downturns while also limiting declines with periodic rebalancing. Buying low and selling high sounds easy in theory, but we tend to get emotional when money is involved. Dollar-cost averaging creates a plan that excitable investors can stick to.

Disadvantages of Fractional Shares

Fractional shares have some downsides as well. For starters, you’ll need to make sure you aren’t killing your account with a thousand papercuts. If fractional share purchases come with commission, you’ll need to be cautious not to rack up trading fees. 

Stock selection can also be a concern. Some brokers may have a diverse group of fractional share offerings, but there’s no guarantee the particular stock you want will be there. Additionally, transferring fractional shares from one broker to another is often a headache-inducing process, so be sure you pick a broker you like.

But the biggest issue with fractional shares is liquidity. Finding a counterparty to buy and sell fractional shares to is more difficult than whole share orders. A lack of liquidity could mean holding shares longer than you previously anticipated and accepting declines beyond your pre-planned limits.

Where to Buy Fractional Shares

With more investors participating in markets thanks to commission-free online brokers and the popularity of meme stock investing, fractional shares are highly sought after. Here are a few of our favorite brokers offering fractional shares:

  • Charles Schwab – Someone at Schwab also likes the pizza analogy since their fractional share program is called Schwab Slices. Clients can purchase any available company for as little as $5 with no commission.
  • Interactive Brokers – The first to ever offer fractional shares, Interactive Brokers offers any US stock for as little as $1 invested. The fee structure is the same as the percentages for individual stocks.
  • Robinhood – Clients of Robinhood can trade share fractions as small as 1/1000000th of a share. Most shares over $1 in price are available for fractional purchases.
  • Fidelity – Stocks by the Slice! More pizza! Fidelity’s Stocks by the Slice program allows clients to buy partial shares of 7,000 different stocks and ETFs for as little as $1.

Other brokers offering fractional shares include Cash App, SoFi Invest, E*TRADE, and TD Ameritrade. Be sure to check with your particular broker of choice for stock availability and ask plenty of questions about fees and commissions. 

Final Thoughts 

“Democratize investing” is a phrase thrown around a lot by new age brokers like Robinhood who want to get new investors into the fray. Most of the time, this is simply a marketing slogan to get new signups, but adding fractional shares and selling them commission-free is a way to let new investors build diverse portfolios without requiring a mountain of money to start.

Buying index funds in a 401(k) is a sound retirement strategy, but many young people would like to build stock portfolios in taxable accounts and simply don’t have the funds to diversify. Fractional shares put diversification in reach for everyone, regardless of income. Just be sure to understand the additional risks that come with partial shares.