Fractional shares are a way for investors to be able to invest in shares, even if the share price is higher than the amount they want to invest. This allows retail investors with small portfolios to get exposure to certain companies.
The price per share of some stocks is high. This makes it difficult for retail investors to deploy their money into these stocks. Fractional shares were created with the intent of allowing access to investments to everyone. No matter how small your portfolio is.
How can you use fractional shares to your advantage?
With the collapse of savings rates across the globe, more people than ever before are turning to the stock market for solutions to their long-term financial goals.
As more investors join the market each year, a high-level analysis attempting to explain this trend might attempt to incorporate the explosion in both the popularity and number of investing apps available for smartphones that have made it easier than ever before for people to participate.
But it may be the mechanism of fractional shares purchases that is providing the fuel for growth in the retail investing industry as this strategy lowers the financial barriers to some of the world’s most valuable companies.
How do fractional shares work?
Let’s use a simple example to illustrate how fractional shares work in the market. For this example, we will use two primary actors, Company A and your average retail investor using a trading app.
Company A’s shares are currently trading for $100.
A trader using an investing app placed $25 into his account and wants to purchase shares of Company A.
Normally, he would be required to have $100 or more in order to do that.
With fractional shares, our investor can put his $25 forward in exchange for that same value of stock amounting to one-quarter of a share or .25 shares at the current market value of the stock.
If the stock goes up in value in the future to $200, our investor’s .25 shares will now be worth $50.
As you can readily see, the dynamics of fractional shares mirror those of whole shares. This gives the retail investor who uses this strategy access to all of the share’s gains - and losses - but at a smaller initial commitment.
What kinds of investors normally take advantage of fractional shares?
For retail investors, fractional investing is proving to be extremely popular. Especially among new traders, and people who want a simple do-it-yourself solution for saving and investing.
Though the dynamics are no different really than whole shares. However, fractional shares are somewhat easier to understand from a new investor’s perspective because they deal purely in dollar values rather than in share numbers.
The really powerful aspect of this strategy comes in two primary forms:
- Access to expensive companies and offering investors a cost-effective diversification method.
- Allows investors to deploy their capital, even if it is a small sum of money.
- Because of how fractional shares work, investors don’t need the full amount of a single share in order to own stock in that company.
- This in turn reduces the risk of being forced to have a concentrated portfolio. Allowing investors to easily diversify across different stocks.
Fractional shares have leveled the playing field for retail investors. However, there seems to be at least one disadvantage, which is highly dependent on the broker you use. Some brokers still charge transaction commissions on fractional stocks. Since retail investors often buy fractional shares with small sums of money the commission might have a large impact on the returns.
As we outlined above, fractional shares allow retail investors to get access to all of the gains and losses that the stock market experiences. While at the same time receiving dividends as well as other payments to shareholders. The second advantage, cost-effective diversification, comes into play when you combine this access with a wider market strategy.
Rather than being limited to a smaller pool of affordable investments. Through fractional shares, investors can funnel their money into various companies at varying levels of risk and reward. Allowing them to harness the powers of diversification to shield them from market downturns. There are also risks associated with fractional shares, that investors should know.
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