In November 2019, Interactive Brokers became the first major online brokers to offer fractional shares trading, giving investors who previously had limited capital and were largely restricted to penny stocks an alternative to investing.
Though more and more big-name stocks come with a hefty price tag, the rise in popularity of fractional shares has helped to usher in a wave of new investors over the past couple of years.
Typically, buying into blue-chip companies comes at a high cost. For example, to buy one share of Google, at the time of writing, an individual would have to invest a sum of about $2,300.
For this reason, many online brokerages have adopted fractional share investing to allow investors to buy shares with as little money as they want.
Thus, purchasing a fractional share means that investors buy a portion of a single share instead of one whole share of a company and can also purchase Exchange-traded funds (ETFs) as fractional shares.
Worth noting is that not all stocks or ETFs offered for sale on an investing platform are available for fractional shares, and depending on the brokerage, you might need to buy at least $1 or up to $5 worth of fractional stock.
BENEFITS OF BUYING FRACTIONAL SHARES
As we have already discovered, fractional shares give those who have just started investing with limited budgets access to the market. It also allows investors to invest a specific dollar amount on a regular basis and help diversify a portfolio.
In addition, since investors don't bet all their money on a single company or industry, building a diversified portfolio can reduce the risk of investing.
If you buy the right companies, your portfolio might easily outpace the broader market and generate long-term wealth, while companies with costly share prices aren't necessarily out of reach financially.
Although amounts may be small at first, the modest contributions can snowball over years of investing with compounding effects.
DRAWBACKS
Not all stocks are available for fractional shares which limit investors from choosing from as many companies as they want.
If investors want to sell their fractional shares and the selling stock does not have a high demand in the marketplace, selling the fractional shares might take longer than hoped.
Also, some brokers might not let you transfer fractional shares to other brokers and you may not be able to exercise voting rights on company matters if you own less than a whole share.
Lastly, the low cost of entry could result in some investors doing less research than is necessary to make well-informed investment purchases, and if too many bad calls are made, investors could end up taking losses in their portfolios.
HOW THEY WORK AND WHERE TO BUY THEM
In simple terms, when someone wants a fraction of a share, a brokerage buys the entire share and "splits" it to investors who want to purchase a specific portion, similar to a stock split.
Large-cap companies like Tesla and Apple often announce stock splits, dividing their current shares into a multiple of new shares. Though each individual stock is now worth less, the total value of the shares remains the same.
A stock split, like fractional shares, makes it easier for individuals to invest in companies' stocks. To buy fractional shares, investors need to open an account with a brokerage that offers this service.
Depending on your broker, investors might have to request access to this additional feature on the trading platform. Then, when you place an order, instead of the number of shares, you should be able to place a dollar amount.
