A Comprehensive Guide to Investing in Fractional Shares

Fractional shares represent an enticing opportunity for potential investors who might be strapped for cash or looking for ways to diversify their portfolios. They let you purchase a part of a stock that corresponds to the amount you can afford rather than the number of shares. This approach is especially beneficial for those with limited investment capital but are eager to create a varied portfolio. In this article, we will delve into fractional shares' nitty-gritty, covering all the basic aspects and answering common questions that new investors might have.

Unpacking Fractional Shares

In essence, fractional shares are just segments of a full share. As the name suggests, you can buy a fraction of a stock according to the dollar amount you're willing to invest, not necessarily the stock's price or the number of shares. It gives investors a more accessible entry point into the market, thereby expediting their market participation.

Though fractional share trading was introduced as far back as 1999, its feasibility and widespread availability only gained traction in 2019. Around that time, many online brokers slashed their fees, allowing fractional share investment to become financially favorable. Prior to this, you might have owned fractional shares due to circumstances like owning mutual funds, stock splits, dividend reinvestment programs, or company mergers or acquisitions.

Navigating Fractional Share Investing

The investment process in fractional shares can vary based on the brokerage you choose. Every brokerage sets its guidelines, and getting clarity on what they offer is crucial before you decide to invest. Here are some considerations:

The availability of stocks for fractional share investing can differ among brokers, as well as their offerings of EFTs.
Some brokers may levy additional charges for fractional shares.
Certain brokers may facilitate real-time fractional share trading, while others may settle all fractional share trades in bulk, impacting the share price due to daily fluctuations between order time and trade execution.

The dividends you receive will also be fractional, corresponding to the fraction of the share you own. For instance, if you invest $25 in a stock trading at $100 per share, you'd own one-fourth of a share. Therefore, if this stock gets a $0.40 per share dividend, you'd receive one-fourth of the dividend, or $0.10.

An example of a brokerage offering fractional shares is Charles Schwab, where they refer to fractional shares as a "slice." Through Schwab's platform, investors can purchase slices of 30 different S&P 500 companies' stocks in one transaction, allowing for flexibility similar to investing in a mutual fund, but with the ability to trade individual stocks or stock fractions.

Steps to Buying Fractional Shares

To invest in fractional shares, you first need to set up an investment account either with an online broker or a robo-advisor. The main distinction between the two depends on whether you want to fully control your fractional share investments or prefer a more passive approach. A robo-advisor lets you set your investment amount and goals, and based on these parameters, selects your fractional share investments and automatically rebalances your portfolio to maintain your goal range.

Research Your Desired Fractional Shares: Fractional share offerings can differ across brokerages, so knowing which stocks you want to invest in can help determine your choice of brokerage.
Open an Account with an Online Broker or Robo-advisor: Ensure that the company you choose offers fractional shares, keeping in mind that each brokerage has its unique nuances for offering fractional shares, such as available stocks for fractional share purchases, how trades are executed and settled, and associated fees.
Fund Your Account: After opening an account, fund it. Many online brokers facilitate funding via electronic funds transfer, but it might take a few days for the funds to settle before you can start investing
Execute and Monitor Your Investment: Most online platforms provide easy-to-use dashboards for portfolio monitoring. You can view all your account holdings at once, and depending on the features offered by your specific online broker, you can also set up stock alerts or automatic rebalancing.

Assessing the Viability of Fractional Shares

Fractional shares offer several benefits, including affordability, diversification, and dollar-cost averaging.

Affordability: You can start investing in fractional shares with some online brokerages for as little as $1, eliminating the need to save up large sums to buy whole shares of a stock.
Diversification: With the availability of fractional shares, investors now have the option to diversify by choosing various stocks, rather than investing all their money into one company to buy a specific amount of whole shares.
Dollar-cost averaging: Regular investments, irrespective of the market's price fluctuations, can hedge against risk and turn out to be beneficial over time.

Recognizing Potential Drawbacks of Fractional Shares

Alongside the advantages, investing in fractional shares comes with its challenges:

Limited stock selection: Not all publicly traded stocks are available as fractional shares. Each brokerage curates its list of stocks that can be bought as fractional shares.
Potential issues when transferring fractional shares: If you want to transfer your account to a different brokerage, you might have to sell your fractional shares first.
Proxy voting might not be possible: Every brokerage has a different policy regarding proxy voting for fractional shares.
Additional fees: Some brokerages may charge additional fees for investing in fractional shares, which can eat into your profits, especially for low-dollar investment amounts.
Trade execution might not be real-time: This could impact your cost basis if your brokerage settles all fractional share trades in bulk orders instead of individually.
Complexity in tax returns: Owning several fractional shares can complicate your tax returns, particularly if your stocks have dividends that you automatically reinvest, resulting in additional tax lots.

Considerations When Investing in Fractional Shares

Before diving into fractional share investing, consider the following:

Availability of stocks and ETFs for fractional share investing: Each brokerage offers a different list of stocks or ETFs for fractional share investing. Check this before opening an account.
Fees and commissions: Some brokerages offer commission-free fractional share investing, while others might charge additional fees. Make sure to clarify this before opening an account.
Account minimums: Most brokerages do not require a minimum balance to open or maintain the account. Balance and investment minimums will differ from broker to broker.
Research amenities and educational content: Your chosen broker should provide valuable resources and educational content to help you make informed investment decisions and understand how to achieve your financial goals.

Do Fractional Shares Earn Money?

Despite investing small amounts, it's feasible to accumulate significant savings over time if you treat fractional share investing as a regular monthly contribution, similar to an IRA or 401k. Over months or years, these fractional shares can amass into several full shares of multiple stocks.

Selling Fractional Shares

The ease of selling fractional shares depends on your brokerage's policies. Some do not guarantee fractional shares' liquidity, which can affect your ability to sell a stock or security and convert it to cash quickly. Although buying fractional shares is often straightforward, selling fractional parts may not be as simple as selling whole shares.

In conclusion, fractional shares present an accessible and cost-effective avenue into the world of investing, allowing individuals to participate in the financial markets irrespective of their budget size. This innovation provides investors the chance to own pieces of companies that may otherwise have been too expensive. Fractional shares can encourage a more diversified portfolio and enable dollar-cost averaging. However, the limited stock selection, potential complexity in tax returns, and issues surrounding liquidity and transferability are challenges to consider.

Remember to do thorough research before diving into fractional share investing. Consider the availability of stocks and ETFs, fees and commissions, account minimums, and the quality of educational content provided by the brokerage. Despite the potential hurdles, the democratization of investing brought about by fractional shares cannot be understated, making it a worthwhile consideration for budding and experienced investors alike.