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.
The stocks of highly-valued companies such as Tesla are usually expensive. For instance, Tesla is currently trading at over $2,200. Not everyone can raise that amount. Fortunately, a trader with limited funds can purchase a portion of the company’s stock.
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.
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.
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.
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.
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.
External Useful Resources
- 3 Reasons to Do Fractional Trading - Fools