Fractional Share Investing

What Is fractional share investing?

Fractional share investing is a way to invest in stock when you do not have a vast amount of capital. With fractional shares, you can invest according to a dollar amount rather than a number of shares in a particular company.

Let’s say a new investor has $1,500 to spend, and they really want to buy Alphabet, Google’s parent company. Considering that Alphabet stock was trading well over $2,000 at the time of writing, $1,500 will not even buy one share!

However, many brokerage firms now split whole shares and sell a fraction to clients, particularly for high-priced, so-called growth stocks like Amazon and Alphabet. In this scenario, the investor might be able to spend some of their money on a partial share of Alphabet stock and the rest on lower-priced stock to create a diversified portfolio.

Robo-advisors, online automatic investment services, such as SoFi, Betterment, and E*TRADE, offer fractional investing, and these digital platforms are opening up the world of investing to anyone, regardless of their capital reserves.

Reasons why fractional shares are created

Other ways that investors acquire fractional shares are through dividend reinvestment plans (DRPs), stock splits, and mergers and acquisitions (M&As).

DRIPs: With a DRIP, a company or brokerage allows an investor to use their dividend payouts from a company’s share to buy more of those shares. Dollar-cost averaging can result in the investor buying fractional shares.

Stock Splits: Stock splits aren’t always even in number. For example, a three-for-two stock split creates three shares for every two. If an investor owns five shares, they would end up with seven and a half shares.

M&As: When two companies merge, their common stock merges according to a ratio, which can create fractional shares.

Fractional shares are not available on the open market. They must be sold through a major brokerage.

According to Investopedia, in November 2019, Interactive Brokers launched fractional share investing of U.S. stocks. Other brokerages quickly followed. Today, automated trading services allow investors to trade in fractional shares in real-time.

What Is the Attraction of Fractional Share Trading?

Investors are attracted to fractional investing for two major reasons: access to revered stocks and minimal risk, because diversification occurs organically.

Access to High-Priced Stock

Only institutional investors or those with bottomless coffers can hope to buy up growth stocks when they go for over $2,000 a pop. So, fractional share investing allows the less well-endowed trader access to more investments and the opportunity to play in the bigger playground.

Built-in Diversification

Fractional share investing has portfolio diversification built-in because investors divide their commitment between any number of assets. Even if you have just $100, you can buy a fraction of shares from companies from, say, 10 different sectors.

What Are the Pros and Cons of Investing in Fractional Share Trading Vs. Traditional Investment Platforms?

The upside of fractional share trading vs. traditional trading on investment platforms is that you gain access to stock you would not otherwise. The downside risk is that you are likely to make more trades, which will result in more fees and less profit. Here’s a more detailed look at the pros and cons.

Pros

Market access – Investors have a wider choice of stocks, including high-value and high-growth stocks.

Specificity – It’s possible to invest a precise amount in a company or exchange-traded fund (ETF) and invest a dollar amount instead of in a number of shares.

Diversification – Buying fractions of stocks means that investors can buy more stocks for optimal asset allocation.

Cons

Market access – Because access is easy, novice investors may rush into an ill-advised investment without doing their due diligence.

Risk – Buying partial shares in stocks is riskier than buying mutual or index funds.

Fees – Investing in more companies means more trades. If a brokerage charges fees or commissions per trade, the cost of transactions can quickly mount up.

Sale of stock – Fractional shares can only be sold through a major brokerage, and low-demand stock might be difficult to unload to a brokerage.

How Can Novice Investors Start Fractional Share Trading?

Investing your own money is time-consuming, and unless you plan to make fractional investing your day job, a robo-adviser can streamline the process.

You will have to sign up with an electronic broker to buy and sell fractional shares. Some recommended brokers are Interactive Brokers, Robin Hood, and Fidelity. Use a broker with zero fees rather than one where you pay per transaction.

Take advantage of any learning resources that you can get your hands on to learn about investing in stock. Most digital brokers provide access to rich educational resources. Also, check out recommended books, podcasts, and discussion forums. Beware of webinars because some of them are purely money makers offered by pundits with no real credentials. The same goes for many YouTube influencers. Use your judgment and get a second opinion before you take anyone’s advice.

Also, depending on the broker you choose, they may have a limited list of companies for which fractional shares are available. Check the companies you want to trade in are on that list before you sign up.

What Are the Risks with Fractional Share Trading?

As the price of growth stocks reached heights that left the average investor gazing longingly into space, new trading apps emerged offering fractional trading. According to Investopedia, Interactive Brokers blazed the trail in 2019, and names such as Charles Schwab, Fidelity, and Robinhood are now well known.

These are established brands, but new apps are emerging all the time that may lack reliable processes. For brokers, fractional share trading is a bookkeeping and inventory management nightmare. Ultimately, the brokerage holds the remaining fractions of stocks, and in the event of a market crash, everyone loses money.

New brokerages are already pressured to offer zero fees to compete with their established competitors, and how long their services will remain sustainable is something to consider. They are likely to either run at a loss or merge, further muddying the pool of firm and client funds. Some may even lock clients out during times of market volatility. In 2019, Robinhood prevented users of the app from liquidating their accounts when investors pounced on GameStop stock, creating massive volatility.

There are also complexities attached to fractional shares if you move a brokerage account to another firm. Only full shares can be transferred and the fractional shares you hold will be liquidated. This could incur tax obligations due to capital gains.

Payment for order flow (PFOF) are fees charged by brokerages to route customer orders to market makers. Market makers carry out the orders according to “best execution,” meaning the best prices for customers. However, PFOF is criticized because it can incentivize brokerages to boost their revenue rather than ensure good prices for customers.

Lastly, there is a risk that novice investors may act recklessly. With easy access to any stock and few limitations, they may fail to do their due diligence.

What Are the Morningstar Trading Platforms?

The following are popular platforms that subscribe to news and recommendations from Morningstar, Inc., a U.S. financial services firm that offers investment research and investment management services.

Etoro

eToro is an investment platform with no commissions attached to fractional share investing. Users can trade cryptocurrencies, and they can trade contract for differences (CFDs). With a CFD, the investor makes money based on the asset’s price change. The investor buys the CFD for which eToro is the counterpart, but the investor does not actually own the stock.

AvaTrade

AvaTrade offers fractional shares through CFDs, typically for short to medium-term trades. For example. CFD trades are high risk because they are not direct financial market trades, but they are flexible because the investor does not own the underlying asset.

NagaMarkets

NAGA offers fractional shares and is a leading digital trading brokerage for the first-time trader or novice. It has tools and resources to help novices learn and start trading. For example, the platform has a library of resources explaining the basics of trading strategy.

MultiBank

MultiBank Exchange Group also provides additional functions using CFD trading, one of which is fractional shares.

FP Markets

FP Markets offers fractional trading using CFDs. Investors on FP Markets can also trade CFDs in Forex, shares, indices, commodities, and bonds.

Zulutrade

Fractional trading is possible using CFDs on Zulutrade. ZuluTrade is an online social and copy trading platform where users can share trading ideas and leave feedback. Copy trading allows users to copy the trades of other, more experience traders.

What Is the Criticism with Fractional Share Trading?

One criticism of fractional share investing by Bloomberg is what they term the democratization of the stock market. According to the media giant and provider of financial news and research, the fact that fractional investing has attracted a wider demographic to the financial markets than the traditional pin-stripe suit crowd is not a good thing. These “new” investors are considered “uninformed” by Bloomberg. They are quite likely to fall prey to the machinations of Wall Street.

Executing trades is now easy for anyone on digital trading platforms, even those who don’t have the money to risk. Investors used to benefit from stock splits, but stock splits have largely dried up. Amazon announced its first split in 23 years in March 2022 when the company’s board approved a 20-to-1 stock split.

Companies typically split their stock when they are bullish and confident that the company will show growth. By splitting stock and lowering the price of each share, investors are more likely to buy the stock and push up the price.

Bloomberg describes fractional shares as “a gimmick” used by brokers who hope that small accounts will convert to large accounts and paying clients. Bloomberg suggests that people are overly optimistic about the remunerative capability of fractional shares. They succumb to social media marketing like “Instagram accounts and influencers with infinity pools and Lamborghinis.”

The outcome of stock market democratization is that novice investors fail to diversify their portfolios and trade speculatively instead of conservatively—buying Treasury bonds, for example—reducing their returns. According to Bloomberg, “fractional shares are just another way for discount brokerages to facilitate this behavior.”

So, now that Bloomberg’s had their say, here are some tips for novice investors.

5 Tips for Profiting from Fractional Share Trading

Fractional share trading is much like traditional share trading. So, develop a strategy based on research. Also, don’t allow your emotions to take over. Rebalance and analyze your portfolio periodically, but give your plan time to work. Here are five tips for fractional share investors.

Use Dollar-Cost Averaging

By setting aside a set amount each month to fractional shares you can leverage dollar-cost averaging. For example, if you have $150 to invest each month and the stock you want to buy is $90, you can buy one share and buy other diversified stocks with the remaining $60.

Think Long Term

There are no get-rich-quick strategies. It takes time and patience to build wealth. Buy wisely and hold onto stocks. Minimize your transactions because you will pay less fees and transaction costs.

Stick to a Plan

Make investment decisions based on a trading strategy and stick to it. Do not let fear or your emotions derail your plan.

Buy Fractional Share ETFs

ETFs are index funds traded throughout the day just like stocks. While traditional index funds can only be traded at the end of the day for a set price. Buying multiple ETFs through fractional shares adds diversification and lowers risk.

Use a Zero-Fee Platform

Investors can be tempted to buy more stocks and initiate more transactions. If a platform charges fees per transaction, the costs will quicky into eat into returns.

Fractional Share Trading: General Terminology

DRIP (dividend reinvestment plan) – When a company that pays dividends or a brokerage allows investors to purchase more shares or a fraction of the same shares with the payouts.

Limit order – An order to buy or sell a stock but with restrictions on the maximum price paid or minimum price received.

Market order – An order to buy or sell a security immediately with no guarantee of the price at execution price. A market executes at or near the current bid (for a sell order) or ask (for a buy order) price.

Price gap – A price gap will occur if a stock’s price makes a sharp move up or down with no trading in between. Price gaps often occur when an exchange opens for trading and news or events outside of trading hours cause share price volatility.

Robo-advisor -A digital platform that allows investors to trade at low cost. These platforms typically offer educational resources and financial advice based on mathematical algorithms.

Stock slice – A partial share of a stock. If a stock is selling at $2,000 a share. If an investor buys $200-worth of the stock, they have 0.1 or 10 percent stock slice of a share.

Stock split – When a company increases the number of shares it has circulating. For example, a 3-for-1 stock split means that each share is now three shares, but each share is worth one-third of its original value.

Stop order – Also known as a stop-loss order, it is an order to buy or sell a stock once the price reaches a specified price, or the stop price. When the stop price is reached, a stop order becomes a market order. A buy stop order is entered at a stop price above the current market price.

Conclusion

Fractional investing provides access to the shares of steamroller companies for investors who couldn’t trade in them otherwise. With some shares like Amazon trading at over $3,000, or Berkshire Hathaway shares at over $450,000 (yes, you read that right), the playing field has been leveled somewhat.

However, critics of fractional investing opine that the smaller investor should not be playing in the big leagues. They would do better to diversify their portfolios with safer options like Treasury bonds or a retirement account.

According to Finance Feeds, there has been a surge in fractional investing, particularly among young investors. More and more trading platforms will be offering this type of trading. An executive from TraderEvolution predicts that it will become a “must-have service” for electronic trading platforms.

If you are interested in fractional investing, choose a trading platform with no fees. Examples include Charles Schwab, Fidelity, or Interactive Brokers. Follow the rules of the road when trading stocks. Develop a trading strategy based on knowledge and thorough research. Stick to your strategy, and do not stake more than you can afford to lose.

FAQs

Are fractional shares a good investment?

Fractional shares are as good an investment as other stocks. If a stock’s price increases 8 percent, you will earn 8 percent on your investment regardless of whether you own a hundred shares or a fraction of a share. Fractional shares are also a way to gain access to equity ownership in companies that you might not be able to access otherwise.

Is there any downside risk to fractional shares?

There are downsides to any type of investing. A trading platform may charge high fees for fractional share trades. Also, an investor may be tempted to make more smaller trades with fractional shares because they have access to more companies. If a broker charges fees per transaction, the costs can quickly mount up.

Do fractional shares turn into full shares?

Fractional shares can become whole shares after a stock split or if an investor buys the remaining fractional shares to make a fractional share whole. Fractional shares are bought and sold from brokers who split shares among multiple investors, but they always add up to a whole share.

What is an example of a fractional share?

A fractional share can occur due to a stock split. Let’s say a company wants to increase its share count to encourage investors to buy more. It might announce a stock split of 3:2. That means that each shareholder who owns two shares will now own three. If they owned 25 shares, they would now own 37 and a half shares. That extra half is a fractional share.

Do fractional shares trade differently to “normal” shares?

Fractional shares don’t trade on the open market. The only way to sell fractional shares is through a major brokerage. Some brokerages that offer fractional shares are Interactive Brokers, Robin Hood, and Fidelity. Fractional shares may be difficult to sell because they must be sold through the same brokerage you bought them from, and there may not be much demand.