Fractional shares have completely revolutionized investing. Shares that were once only available for investors with large sums of capital are now available to every investor despite the size of their portfolio.
This democratization of investing has allowed thousands of individual investors to start their investment journey, which would otherwise be impossible.
However, it is important to understand what are the advantages and disadvantages of fractional shares, and how they compare with whole shares.
What are fractional shares?
Fractional shares allow investors to invest a fixed dollar amount into a share, even if its price is higher than the investment they are willing to make. This means that investors can get invest in companies whose stock price is higher than the amount they are willing to invest.
For example, if a stock is trading at $1,000 and you just want to invest $100, you will end up with 10% of a a whole share.
What are whole shares?
A whole share means that you own the share entirely. The concept has been popularized after fractional shares became popular in order to make the distinction between fractional shares and owning 1 share of a certain stock.
Fractional shares vs whole shares advantages
Fractional shares offer several advantages to investors, such as:
- Invest a fixed dollar amount
- Ability to own any share regardless of your portfolio size
- Diversification even for smaller portfolios
- Ability to do dollar-cost averaging even with small sums
- Easier to manage your portfolio, and exposure
- Makes it easy for retail investors to invest in any stock they want
Invest a fixed dollar amount
Fractional shares allow investors to add a fixed amount of money into their portfolios. Since you are buying in dollars instead of shares, you can decide to invest a fixed amount of money into the portfolio. With whole shares, you would be limited by the cost of each share.
Own any share regardless of your portfolio size
This makes it easy to own just about any share in your portfolio regardless of its size. Even if you have a $1,000 portfolio you can still invest in the stocks you want, and the exact amount you want.
Dollar-cost averaging is easier
Let’s say you want to follow a dollar-cost averaging strategy on a daily basis, but if the amount you want to add to your portfolio daily is too low, then fractional shares are the perfect solution. It allows you to add on a dollar-cost average basis, shares of any stock you want.
Easily manage your portfolio
Another great advantage of using fractional shares is that allows investors with small portfolios to manage their exposure, without being limited by whole shares.
What is the major benefit of fractional shares?
Fractional shares allow investors with portfolios of all sizes to invest in the stock they want. Years ago this was not possible, and in order to invest in a particular stock, an investor needed the amount that equaled at least one share. This limited the ability of retail investors to invest in what they wanted or to keep a diversified portfolio.
Fractional shares vs whole shares disadvantages
Despite the numerous advantages of fractional shares, there are several disadvantages when compared with whole shares. Here are some of the main disadvantages:
- Lower liquidity
- Higher fees
- Not every broker offers them, and the rules change depending on the broker
One of the main disadvantages of fractional shares is that they have less liquidity than ordinary shares. The reason is that there are not a lot of investors trading them, especially if the company has a smaller market cap.
This makes fractional shares risky, as it might take a lot of time to get your order filled if you are trying to buy and trade.
Depending on the broker you are using to trade fractional shares, it might charge you a very high commission relative to your total order value. These fees end up accumulating and being a meaningful expense when compared with your total portfolio.
For this reason, you should avoid brokers that offer fractional shares and still charge high commissions.
Dividends are difficult to process when it comes to fractional shares because sometimes they will be an unpayable amount. This means that if you are getting a dividend from a fractional share, you may lose some money along the way.
Since dividends are still paid but they have to be rounded by the penny based on the ownership you have of the whole share.
Finally, there are some brokers that do not offer fractional shares or they might still charge high trading fees. Additionally, depending on the broker there are different rules when it comes to fractional share ownership.
It is advisable for you to read and analyze each of them before choosing the right broker. You may also have multiple brokerage accounts, in order to benefit from what they offer, but this can be costly.
One of the most popular brokers for fractional shares is Robinhood.
There are clearly some advantages of investing in fractional shares vs whole shares, and if you are just starting out, this could be the best approach. Over time, and as your portfolio grows you should try to switch to whole shares, as they tend to be safer, and offer more liquidity.