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Investing in the stock market can be intimidating, especially for those who are new to it or have limited funds. Fractional shares have emerged as an innovative approach to investing, making it more accessible and affordable.
In this guide, we will explore the concept of fractional shares, their benefits, how to invest in them, and the risks and limitations associated with them. We will also compare fractional shares with traditional shares to help you determine the best option for your investment needs.
Understanding Fractional Shares
Fractional shares are essentially smaller pieces of a whole stock, allowing investors to purchase a portion of a share rather than a full share. This concept has gained traction in recent years as it enables individuals with limited financial resources to participate in the stock market and build a diverse portfolio. Let’s delve deeper into the world of fractional shares.
What are Fractional Shares?
Fractional shares are a fraction of a single stock. Traditionally, you would have to buy whole shares of a company, but with the advent of fractional shares, you can now buy a smaller portion of a single share.
Fractional shares have become increasingly popular among investors as they offer more flexibility and accessibility. With fractional shares, investors can invest in high-priced stocks without having to pay the full price for a single share. This opens up a whole new world of investment opportunities for individuals who may not have had the financial means to invest in the past.
Moreover, fractional shares allow investors to diversify their portfolios more easily. Instead of investing all their money in one or two high-priced stocks, investors can now spread their investments across multiple stocks, even if they only have a limited amount of money to invest.
How do Fractional Shares Work?
Fractional shares work by allowing investors to purchase a specified dollar amount of a share rather than buying whole shares.Brokerage platforms that offer fractional shares use complex algorithms to execute these trades by combining multiple investors’ orders and then dividing the shares accordingly.
For example, if a stock is priced at $100 and an investor wants to invest $50, the brokerage platform would purchase 0.5 shares of the stock on behalf of the investor. The investor would then own a fractional share of the stock, which would increase or decrease in value based on the stock’s performance.
One of the benefits of fractional shares is that they can be bought and sold in much the same way as whole shares. Investors can place buy or sell orders for fractional shares just as they would for whole shares, making it easier for investors to get started in the market and gradually build their investment portfolios.
Pros & Cons of Fractional Shares
Affordability and Accessibility
Allows for Dividend Reinvestment
Fees & Costs
The History of Fractional Shares
While fractional shares have gained popularity in recent years, the concept dates back to the 1990s with the introduction of dividend reinvestment plans (DRIPs). DRIPs allow investors to reinvest their dividends in the form of additional shares, which often resulted in fractional shares due to the dividend amount not always aligning with the stock price.
However, it wasn’t until the rise of online brokerage platforms and technological advancements that fractional shares became accessible to retail investors. As more platforms began offering fractional shares, the barriers to entry for many new or budget-conscious investors were significantly reduced.
Today, fractional shares have become an integral part of the investment landscape, providing investors with greater access and flexibility in the stock market. As technology continues to advance, it’s likely that fractional shares will become even more prevalent, opening up new investment opportunities for individuals around the world.
Benefits of Investing in Fractional Shares
Many advantages come with investing in fractional shares, including increased affordability, portfolio diversification opportunities, and the potential for dividend reinvestment. Let’s explore these benefits in greater detail.
Investing in the stock market can be intimidating, especially for those who are new to the game. However, fractional shares have made it possible for anyone to invest in the stock market, regardless of their budget or experience level.
Affordability and Accessibility
One of the main benefits of fractional shares is the ability to invest in companies or exchange-traded funds (ETFs) that may have been previously unaffordable due to their high stock prices. This opens the door to investing in well-established, high-performing companies that could serve as the cornerstone of a strong portfolio.
For example, let’s say you’ve always wanted to invest in Amazon, but its stock price is over $3,000 per share. With fractional shares, you can invest as little as $5 in Amazon and still own a small piece of the company. This means that you can invest in multiple high-priced stocks without breaking the bank.
Additionally, with the possibility to invest smaller amounts, new investors can dip their toes into the market without taking on significant financial risk. This can help increase financial literacy and encourage more individuals to participate in the stock market and take control of their financial future.
Investing in a wide range of assets helps mitigate risks, and fractional shares are no exception. The affordability of fractional shares enables investors to allocate their funds across various industries, sectors, and market caps, spreading risk and potentially increasing long-term returns.
For instance, an investor with a small budget can invest in high-priced stocks, such as tech giants or blue-chip companies, alongside lower-priced stocks and ETFs, creating a well-rounded and diversified investment portfolio. This diversification can help protect against market volatility and potentially increase returns over time.
If a company or ETF pays dividends, those dividends can often be reinvested in the form of additional fractional shares. This is especially beneficial for long-term investors, as it enables them to compound their returns by continually adding to their positions without incurring additional fees or costs.
For example, let’s say you own ten shares of a company that pays a $1 dividend per share. Instead of taking the $10 in cash, you can reinvest it in the form of an additional fractional share. Over time, this can add up and lead to significant returns.
This strategy, known as dollar-cost averaging, helps smooth out market fluctuations and can lead to a more robust portfolio over time. By reinvesting dividends, investors can take advantage of the power of compounding and potentially increase their returns.
Risks and Limitations of Fractional Shares
As with any investment, there are risks and limitations to consider when investing in fractional shares. Before diving into this investment strategy, it’s essential to weigh the risks and understand the potential drawbacks.
One of the risks of investing in fractional shares is the potential for market volatility. The stock market can be unpredictable, and even the most well-researched investments can experience sudden drops in value. Fractional shares may be more susceptible to these fluctuations, as the smaller investment amounts can magnify losses.
Fractional shares may have limited liquidity compared to whole shares. This means that selling fractional shares could be more challenging, as there may not always be a buyer interested in purchasing them. Additionally, some fractional share sales may require extra time for the brokerage platform to find a suitable buyer, potentially delaying the sale.
It’s important to keep in mind that liquidity concerns may vary depending on the stock or ETF in question. Popular and highly traded securities may have more liquidity for fractional shares, while less popular or thinly traded securities may have less liquidity.
Not all stocks and ETFs are available for fractional investing. Some brokerage platforms may offer a limited selection compared to the number of stocks and ETFs available for whole-share investing. This constraint could potentially impact your ability to create a fully diversified portfolio.
However, it’s worth noting that the selection of available fractional shares is growing as more brokerage platforms offer this investment option. As fractional investing becomes more popular, it’s likely that more stocks and ETFs will become available for fractional purchase.
Fees & Costs
Another consideration when it comes to potential returns is the fees associated with fractional investing. Some brokerage platforms may charge additional fees for fractional share purchases or sales, which can eat into your returns.
It’s important to research the fees associated with your chosen brokerage platform and factor them into your investment strategy.
How to Invest in Fractional Shares
Investing in fractional shares is an excellent way to get started in the stock market without breaking the bank. It’s a simple process that requires a few straightforward steps, but it’s essential to do your research and make informed decisions.
In this guide, we’ll go over the steps involved in investing in fractional shares and provide some tips to help you get started.
1. Choose a Brokerage Platform
The first step in investing in fractional shares is to choose a brokerage platform that offers this option. Not all platforms provide fractional shares, so it’s crucial to research and compares different options before signing up.
Some factors to consider when selecting a brokerage platform include:
An extensive range of available stocks and ETFs
A user-friendly interface
Strong customer support
Some popular brokerage platforms that offer fractional shares include Robinhood, Fidelity, and Charles Schwab. Each platform has its pros and cons, so it’s essential to do your research and choose the one that best meets your needs.
2. Set up an Investment Account
Once you’ve chosen a brokerage platform, the next step is to set up an investment account. This typically involves providing your personal information, Social Security number, and bank account details.
Once your account is verified and funded, you’re ready to start investing in fractional shares.
3. Select Stocks and ETFs
Research is a crucial aspect of investing, and this is especially true when selecting stocks and ETFs. It’s essential to do your due diligence and assess the performance, financial health, and potential growth of your chosen investments.
Consider investing in a diverse mix of assets to reduce risks and increase the potential for long-term gains. This includes investing in companies and ETFs across different sectors, industries, and market caps.
Some popular ETFs that offer fractional shares include the Vanguard Total Stock Market ETF (VTI), the SPDR S&P 500 ETF Trust (SPY), and the iShares Russell 2000 ETF (IWM).
4. Place Orders for Fractional Shares
Once you’ve decided on the stocks and ETFs you want to invest in, it’s time to place an order. To purchase fractional shares, you’ll typically need to specify the dollar amount you wish to invest in a particular stock or ETF.
Some brokerages may have minimum investment amounts, so be sure to check their requirements before placing an order.
Once your order goes through, you’ll receive a confirmation with your newly acquired fractional shares. As with traditional share purchases, it’s essential to monitor your investments, stay informed about market trends, and adjust your strategy as needed.
Fractional Shares vs. Traditional Shares
When deciding between fractional shares and traditional whole shares, it’s essential to understand the key differences between these investment options and determine which is the best fit for your financial goals and risk tolerance.
Buy a specified dollar amount of a share
Buy complete shares of a company or ETF
More accessible and affordable for a wider range of investors
Higher investment requirements
Increased diversification opportunities
Limited to whole shares
Potential liquidity concerns due to limited buyers for fractional shares
Typically more liquid
Limited availability for certain securities or investment types
Potential for lower returns in the short term due to smaller investment amounts
Potential for higher returns in the long term
Ultimately, the decision between fractional shares and traditional shares depends on your investment goals, budget, and risk tolerance. If you’re a new investor with a limited budget, fractional shares can be an excellent starting point as they provide an affordable and accessible entry into the stock market. Similarly, if diversification and dividend reinvestment are crucial to your investment strategy, fractional shares may be the ideal choice.
On the other hand, if you have sufficient funds to invest in whole shares and prefer a more traditional approach, whole shares may be the better option. Whichever route you choose, it’s essential to maintain a long-term perspective, conduct thorough research, and consistently monitor your investments to achieve financial success.