By using fractional shares, investors may purchase a portion of a firm, which makes it easier for them to diversify their holdings even with negligible amounts of cash. In addition, because stock splits do not always result in an equal number of shares being owned by each shareholder, they often produce fractional shares.
Fractional shares are produced when two companies unite their new common stock using a fixed ratio. The outcome of a merger or acquisition may cause this. Capital gains, dollar-cost averaging, or dividend reinvestment plans will result in an investor having fractional shares. Since fractional shares do not trade on the open market, the only way to sell them is via a big brokerage.
Types of Fractional Shares
- DRIPs, or dividend reinvestment plans, often lead to the formation of fractional shares. For example, a company or brokerage that distributes dividends to shareholders may offer investors the chance to use dividend payments to purchase more shares of the same company via a dividend reinvestment scheme.
- Next is stock splits. The allocation of shares in the event of a stock split may not be fair. For example, if an investor already possessed an odd number of shares before a 3-for-2 stock split, they would end up with a fractional share. This is because the split would generate three new shares for every two existing shares.
- The formation of fractional shares may occur due to mergers and acquisitions or M&As since companies unite new common stock according to a preset ratio. Because of the ratio, shareholders often get fractional shares. In addition, some brokerage houses deliberately divide full shares to allow customers to purchase fractional shares. This kind of share partition occurs most often with expensive equities, such as Amazon and Google’s parent company.
Why do individuals choose fractional shares?
- A cost-effective approach to entering the stock market if you have your eye on an expensive stock but don’t want to invest all of your money in one company is acquiring fractional shares, which a few online brokerages provide.
- Due to the availability of fractional shares, investors may purchase stock based on a dollar amount rather than the price of a whole share. Investors working with a paltry amount of money but who want to build a well-diversified portfolio may find this very helpful.
- The equities that are most in demand with investors today also tend to be the most expensive. To build a diversified portfolio with only a few shares of each asset, you may need to make an initial investment of tens of thousands of dollars.
- Let’s say you have $7000 ready for investment. By acquiring fractional shares, you have the option to allocate a precise sum of money to any firm in which you decide to take part. If so, you could invest $700 in each of the ten different companies, regardless of how much each share of stock would cost.
Things to watch for when buying fractional shares
- According to CNBCE, investors must also consider other factors when buying fractional shares, such as their investing goals, time horizon, degree of risk tolerance, and level of risk capacity.
- In all the businesses they invest in, an investor has infinite fractional shares to buy. So instead of the total number of shares invested in a range of companies, investors should examine their portfolios based on the amount of money invested in each stock or ETF.
- If you are a fractional share investor, you should be aware of the overall amount of money invested in each company and how diversified they are. It is more dangerous to have an abnormally high percentage of a portfolio invested in just one business or one market sector than to hold a greater number of shares in one company than shares of another company.
- Investments in index funds and/or exchange-traded funds (ETFs) that reflect the larger market, such as the S&P 500, are excellent ways to diversify your portfolio and safeguard your assets from danger.
- It is a good idea to look for an investment platform that doesn’t charge a fee for each transaction if you wish to purchase fractional shares via that platform. You can be sure that you won’t have to pay any extra fees by doing this. The trading costs or tax ramifications linked to different platforms may negatively affect overall earnings when buying or selling partial shares.