If fintech is democratizing personal finance, then fractional share investing is great evidence of that trend. Investing in stocks traditionally has had high barriers to entry. Fractional share investing makes investing in individual securities available to anyone. The walls have fallen.
Just because you can, however, doesn’t always mean you should. There are pros and cons. As with any financial decision, investors need to weigh the tradeoffs.
What Are Fractional Shares?
Fractional shares are just what they sound like — a fraction of a share of a stock or other investment.
Company stocks are traditionally sold on exchanges in lots of 100 shares, although you could purchase as little as one share. There was not a way for investors to purchase less than a whole share, not until fractional shares.
Investors purchase fractional shares by specifying the dollar amount they want to invest instead of specifying the number of shares they want to purchase.
For example, if the investor has $20 to invest and wants to purchase a stock trading for $100 per share, they would use their $20 to purchase one-fifth of a share.
Many stocks are priced at levels where the average investor cannot afford to buy individual shares. Some stocks trade for a few thousand dollars per share; Berkshire Hathaway’s A shares trade for nearly $400,000 per share. That’s a large barrier to entry for investors.
Things You Should Know Up Front
You can invest in fractional shares through some brokerages and with some apps. Most brokerages offering fractional shares are doing so without trading costs, as are most apps. Trading costs would make fractional share ownership cost prohibitive.
Typical brokerage fees would make owning single shares cost prohibitive in many cases; it would be even worse for fractional shares.
Not all outlets for fractional shares offer all shares as fractions. Some offer all publicly traded stocks and ETFs; others offer a limited selection.
Depending on your objectives, you may need to give consideration to the breadth of offerings before signing on.
You may not be able to transfer a fractional share account in kind. Since the rules and availability of fractional shares vary from brokerage to brokerage, there can be obstacles to transferring to another brokerage.
Certainly, you could sell out of your positions and repurchase them elsewhere, but that could have tax implications, so be careful with that strategy.
If you own a fraction of a dividend paying stock, you are entitled to a fraction of the dividend. For example if you own .134 of a share of a stock and it pays a dividend, you would get .134 of the dividend. You have the rights of the share in proportion of your ownership.
Advantages of Fractional Investing
It is realistic that an investor with a couple hundred dollars could invest in individual shares of a stock; it is not realistic that they could be diversified with whole individual shares. Fractional investing allows investors to build a diversified portfolio with a very small amount of money.
Many investors add systematically to their accounts. They do so by allocating a portion of their income on a periodic basis, whether weekly or monthly, into their investment accounts.
If you are investing in whole shares, you may have to accumulate funds in your account until you have sufficient funds to purchase a whole share. Fractional investing allows you to put your funds to work immediately as this barrier is removed.
Fractional investing allows beginning investors to gain experience with less capital at risk. Oftentimes individuals accumulate a pool of dollars, then wade into the choppy waters of investing with no experience.
Fractional investing allows beginners to gain experience, and possibly some profits, before they have accumulated a significant pool of money.
Disadvantages of Fractional Investing
Removing the barriers to entry to investing is both a blessing and a curse. Certainly everyone who wants to invest should be able to do so to the extent that their means allow.
In that way, fractional investing is a blessing: It allows those who had been priced out of the markets the same opportunities as everyone else.
There is no requirement, however, that anyone entering into the market know what they are doing. In most cases, investors will enter into fractional investing without any human interaction — there is no gatekeeper who might suggest to the investor that the risk they are assuming may be larger than they think.
Buying stocks is not for everyone. You can lose money. And you likely will, at times.
Just because getting into investing is easier, doesn’t make investing successfully any easier.
Because fractional investing is relatively newer, investors may find challenges changing brokerages if they find theirs is not meeting their needs.
Some brokerages offer all publicly traded stocks and exchange-traded funds (ETFs) as fractional shares; others have a limited list. You will not be able to always transfer in kind from one firm to another.
The Bottom Line
Investing is still a long-term game. Most people still place a lot of emphasis on short-term risk to the detriment of long-term performance.
And it is in long-term performance where most people cannot afford to succumb to risk aversion; they’re over focusing on volatility and therefore reducing their chances for a comfortable retirement.
Fractional shares have all the risks of whole shares, just in smaller bites. But the investors may be equally unable to afford losses.
Many investors shy away from individual issues because that is what they heard they should do on the internet and elsewhere. There is nothing wrong with the advice to invest into index funds, but there are reasons for investors to pursue other strategies as well.
The financial writers love to point out how more than 80 percent of professional managers fail to beat the market over various timeframes. They don’t point out that 100 percent of index investors fail to beat the market over every single timeframe.
Index investing is wonderful; it provides average returns with below average costs. Costs are cancer to investments; they erode real rates of return and should be minimized to the extent that is practical.
For many investors, index investing is fantastic, you get decent returns with low fees and you don’t have to do much work or put in much thought — it is not, however, the answer for everyone.
There is a chance that fractional shares bring a lot more people into the investing fold.
Some of those people will develop a further interest in their financial wellbeing and fractional investing will be their springboard to a brighter financial future. They can build a diversified portfolio with any amount of money. And they can purchase an index ETF if they want.