Fractional shares are an important part of the market today. A fractional share is where you buy a small part of a company’s stock.
For example, assume that a stock is trading at $5,000 and you have $100. In a normal situation, it means that you cannot buy the stock. But with fractional shares, it means that you can buy 0.02 shares of the stock.
The same concept work in the cryptocurrency market where it is possible to spend $200 to buy a portion of Bitcoin that is trading at $30,000.
In short, a fractional share is a slice of the full share or ETF. It results from various corporate actions such as dividend reinvestment plans (DRIPs) or stock splits.
Depending on the broker, you can buy as low as 1% of a stock.
How Do Fractional Shares Work?
In a typical setup, one trades in whole units. However, with fractional shares, a share is divided into several units and distributed to the buyers. To purchase a fraction of a stock, you simply indicate the amount you intend to buy or sell.
When buying a fractional share, the broker follows some steps to execute the trade.
The Broker’s Steps
- Depending on the buyer’s order, the broker will purchase the entire stock and slice it up to suit the purchasers.
- Alternatively, the broker can use the route of the execution algorithm, which is usually compiled automatically. With this, the broker waits for orders from other traders. Subsequently, the orders are assembled into a block order before being executed.
- Upon execution, the fractional shares are distributed into each trader’s account.
Fractional vs Full Shares
It is important to note that fractional shares are similar to full shares, only that they are a slice of the whole unit. For this reason, you are entitled to dividends if you trade in the shares of a dividend-paying company. The acquired amount will depend on the purchased portion of the stock.
Where to Trade
Robinhood, Charles Schwab, and Fidelity are some of the online brokers that sell fractional shares. You can also consider apps such as SoFi Invest, Cash App Investing, and Stash. The brokerage firms have different terms and available fractional shares.
Are Fractional Shares a Good Idea?
Fractional trading is a good idea, both for experienced and novice traders. In most cases, one may not afford to trade in the shares of highly-valued companies like Tesla, Apple, or Amazon.
Fractional shares enable you to trade in a stock based solely on the performance of the company rather than the funds in your account. With limited funds, you are still able to build a diverse portfolio.
Nonetheless, it is crucial to take a look at different brokers’ fees and the available fractional shares before making a decision.
The liquidity factor
A key question that is commonly asked by many people is whether fractional shares are liquid or not. Fortunately, most stocks that you know are highly liquid.
These include stocks like Apple, Amazon, Meta Platforms, and Tesla are highly liquid. This means that you can buy and sell the stock at any time.
The most illiquid stocks are actually small-cap and penny stocks and not large companies.
Portfolio creation using fractional shares
One strategy of using fractional shares is to create a portfolio especially when you don’t have a lot of money.
For example, if you have just $2,000, you can only invest in just 10 shares for a company trading at $200. However, with fractional shares, you can buy a few companies with $2,000. This explains why fractional shares are so important.
Related » The Power of Stock Diversification
Do fractional shares pay dividends?
A fractional share is similar to a full share. This means that a person who owns 1 Amazon share is similar to one who owns half a share.
So yes, fractional shares pay dividends. The difference is the amount. Therefore, if the person who owns 1 share receive $5 in dividend, you will receive $2.5.
Can you sell fractional shares?
As mentioned, fractional shares are similar to other full shares. The only difference is that they enable people to own a small number of shares.
For example, if you have $100 and a stock is trading at $2,500, you can buy 0.04 shares. Therefore, since you can buy these shares easily, you can sell them easily.
Pros and Cons of Fractional Shares
Like any other investment opportunity, it is important to understand the advantages and disadvantages of dealing in fractional shares before venturing into it.
Pros
You are able to trade with a small amount of funds. In the past, most brokers placed minimum balance requirements. Besides, one had to trade in full shares. This expensive structure barred those with limited funds from dealing in the top stocks.
Fortunately, you can now trade in shares with just a few dollars.
You can trade stocks of highly valued companies that you otherwise couldn’t afford. In a typical setup, traders with little funds focus on penny stocks. Notably, these companies are usually a high-risk and low-return option.
However, with fractional shares, no company is beyond your reach. You can trade in the shares of well-established companies like Amazon and Tesla for a fraction of its stock’s price. As such, your trading decisions will be based on the performance of the company rather than the funds at your disposal.
It makes it easy to have a diversified portfolio: diversification is part of an effective risk management strategy in trading. Instead of placing all your money on one stock, you can spread out the funds by dealing in a small part of shares of several companies within different sectors.
Cons
Possibility of increased fees: with fractional shares, one is able to trade in the stocks of different companies. If your broker charges commissions or other trading/non-trading fees, you may end up paying hefty charges.
The option is not available everywhere: not brokers allow traders to deal in fractional shares. Besides, not all stocks are subject to this fractiotions.
As such, you may end up trading with a brokerage firm or in a stock that wasn’t your first choice.
Final Thoughts
With fractional shares, you can trade in stocks that you otherwise couldn’t afford. If the company pays dividends, your fraction will also earn you dividends that are proportional to the size of your stock.
While fraction trading is a good idea, it is still important to enact effective risk management strategies. Besides, before dealing with a particular broker, go through their terms and their availability.
