It seems like a great idea in theory: break up your shares of a company and sell them off in small pieces to more people, but are fractional shares bad or good? What are the pros and cons, and should you invest in them?
Fractional shares are a way to get into the stock market without having to spend a fortune, and you don't need to be an expert on stocks to make money. However, you need to consider the advantages and disadvantages of investing in fractional shares.
Advantages of fractional shares
1. Start investing with a small portfolio
One of the major advantages of fractional shares is that it allows investors with portfolios of all sizes to start investing. This removes the barrier that once existed, which prevented people with fewer funds to be able to invest in the stock market.
Fractional shares allow each investor even with a small portfolio to be able to invest in the most well-known companies.
2. Dollar-cost averaging is easier
One of the most common investing strategies used by investors with smaller portfolios, that want to take a more passive approach to investing is dollar-cost averaging. Fractional shares allow investors to use this strategy by adding a fixed dollar amount of money to their open positions.
Instead of having to worry about having enough funds to buy one or two shares of a certain company.
3. Investing a fixed amount of dollars
Another great advantage of fractional shares is that it allows you to invest a certain amount of dollars into a stock. Let’s imagine you want to invest just $100 into Apple, you don’t have to worry about whether the stock is $200 or $300, you can just put that money to work right away.
This proves to be a great advantage, and for many years investors were restricted to buying at least one whole share.
4. Diverisfy without worrying about your portfolio size
Diversifying your small portfolio was also difficult until fractional shares were created. Before you would need the amount at which a stock was trading, to be able to buy it. This forced many investors to have concentrated portfolios, sometimes of a single stock, without being able to have a diversified approach to investing.
5. Invest with as low as $1 per stock
Currently, some of the most well-known brokers that offer fractional shares allow you to buy as low as $1 of a single stock. This removes any barriers to investing that previously existed, allowing everyone to be able to invest in the stock market.
Disadvantages of fractional shares
1. Lower liquidity
One of the biggest problems with fractional shares is that they are not as liquid as whole shares. This means that it can be difficult to find someone willing to buy them from you, and you may have to accept a lower price than you would for a whole share.
This is a disadvantage because it means that you may not be able to get your money out as quickly as you want, or that you could lose money if the stock price falls before you can sell. With lower liquidity, there is also a greater chance that the spread between the asking price of the sellers, and the bid of the buyers is slightly bigger than the whole shares.
2. Higher fees
Another issue is that brokers usually charge similar fees whether or not you are trading whole shares or fractional shares. This is because brokers typically charge a commission on each trade, and these commissions can add up quickly if you're buying and selling multiple fractional shares.
Additionally, because fractional shares tend to be cheaper, the commissions also represent a larger percentage of the money you are investing, which might not seem like a lot at first, but after a few trades, it can be a large percentage of your portfolio.
A few percentages may not seem like much, but they can eat into your profits if you're not careful.
For example, let's say you buy 0.1 of a share 10 times over a month and are charged a $1 commission each time. That's a total of $10 in commissions, just to buy one share.
Compared to saving up and buying it at once for just $1 in commission for the single buy order for the same amount of share ownership.
3. Limited voting rights
Fractional shares often come with limited voting rights. This means that you may not have a say in important company decisions, such as who is on the board of directors. This can be a major downside for investors who want to have a say in how their companies are run.
Some investors may not care about their voting rights but large investors with a significant amount of money invested in a company may want more control. If a company you know has the potential to do great things, but you don't like the way it's being run, then owning fractional shares may not be the best idea.
4. Can lead to over-diversification
One of the main risks with fractional shares is that it can lead investors to over-diversify their portfolios, by adding small pieces of shares of different companies. This is detrimental, because it may over-diversify the portfolio while racking up a lot of money paid in fees over that period.
5. Not every broker offers fractional shares
Something that should also be considered is the fact that not every broker offers fractional shares to their customers. For this reason, you need to be careful when selecting a broker, or if you have a broker already you might need to have multiple brokerage accounts, to be able to invest in fractional shares.
6. Not every stock has fractional shares
Lastly, if you are interested in investing in fractional shares you need to understand that not every stock has fractional shares that you can invest in. While most well-known companies and large caps have fractional shares, some foreign and small-cap stocks do not have fractional shares.
Are fractional shares worth it?
With fractional shares, you can invest just pennies into a company, but is it worth the effort? For some people, the answer may be yes. But for others, it may not be worth their time and energy to invest such a small amount of money.
Over-diversifying your portfolio with fractional shares could lead to more work for you in the long run. You may have to keep track of dozens or even hundreds of different stocks, which can be time-consuming. If you end up diversifying with fractional shares, you may have been better off with an index fund (exchange-traded fund).
You may also find that the company you want to invest in doesn't offer fractional shares. In this case, you would have to either buy a full share or find another company that does offer them.
Fractional shares can make it more difficult to track your investment performance. This is because you will now have more positions in your portfolio, and it can be tough to keep track of how each one is performing.
Overall, while fractional shares can offer some benefits, there are also several drawbacks that investors should be aware of before they begin trading them. If you're thinking about investing in fractional shares, be sure to do your research and understand the potential risks involved.
For investors that want to start investing early without a large amount of money, fractional shares are the ideal way to get started.
Overall, fractional shares can be a great way to get started in the stock market without breaking the bank. However, there are some drawbacks that you should be aware of before investing in fractional shares. Especially when comparing them with whole shares.
Investors should carefully consider these drawbacks before deciding to invest in fractional shares. While they may seem like a good way to get started in the stock market, there are potential problems that could offset any benefits
Fractional Shares FAQ
Are fractional shares actual shares?
Yes, fractional shares are still actual shares and give investors part ownership in a company. However, they are not whole shares, which means they have some limitations when it comes to trading and investing in them.
Do fractional shares earn dividends?
Just like whole shares, fractional shares also earn dividends proportionate to the fraction of the share you own. So if a stock pays a $1 dividend and you own half of a whole share or 50%, you will be entitled to receive a $0.5 dividend.
Can you make money on fractional shares?
Fractional shares work in the same way as whole shares, and it is possible to generate a return and make money on both whole shares and fractional shares.
What happens to fractional shares when you sell?
You can buy and sell fractional shares the same way that you would with whole shares. The only limitation is that the liquidity in fractional shares is lower because the number of buyers of fractional shares is smaller than whole shares.
Additionally, some brokers also charge the same fees for fractional share trades as they do for whole shares, and this can be expensive in the long run.
Are fractional shares taxable?
When it comes to taxes, fractional shares are taxable just like whole shares. For this reason, you should keep track of all your trades, or you can also ask your broker to provide you with the information required to fill out your tax return.