You may have seen or heard of people investing in big companies with expensive share prices for as little as $1. You might have then questioned if this was true or not because a single share of a company such as Amazon is around $3,300. With the concept of fractional shares, however, investing in a large company for as little as $1 or $5 is possible.
What are fractional shares?
When you invest in a fractional share, you are able to name your price when you are investing in the stock. For the amount of money you put down, you will get a proportional fraction of the share you want to invest in. For instance, if you want to invest in Apple, but you only have $25, you can still invest even if a share of Apple costs $1,000. If Apple is trading for $500 a share and you want to invest $25, you would get 5% of a share. This is a game changer for beginner investors or investors that don’t have a lot of money to invest. Prior to fractional shares, these types of investors were priced out of investing in companies such as Netflix or Amazon because they didn’t have thousands of dollars to invest.
The concept of fractional shares is not new. With dividends, companies can use stock to give part of their profits back to their investors. Many investors will just reinvest these dividends so if you owned a share of a $100 stock that paid a $5 dividend and you reinvested it, you would be getting 5% of the share. It is also similar to what you will receive if you invest in an exchange-traded fund (ETF) or in a mutual fund. With these, each share is invested in a small stake of various companies. In this case, you own shares of the fund, not fractional shares of the companies the fund is invested in.
How do I buy fractional shares?
Prior to fractional shares, if you wanted to buy a stock, you would have to have enough money to buy at least a single share. Some stockbrokers would not do business with you unless you purchased round lots, or share orders in multiples of one hundred.
These days, online brokerages have made it much easier to buy small amounts of stock. However, because of commissions, purchasing a single share does not make a lot of sense most of the time. If you pay a $10 commission to buy a $100 stock, your returns won’t really be worth it.
Investment apps such as SoFi and Robinhood were some of the first to start offering fractional shares. As of last year, many other traditional brokerages such as Fidelity and Charles Schwab followed suit. This is most likely because the popularity of fractional shares has risen dramatically in the past year because people have started stock trading in larger numbers. Many brokerage platforms also offer trades with no commission which has let many people invest smaller amounts than they used to.
What kinds of stocks can I buy?
Today, you can purchase fractional shares of ETFs and stocks. These are bought and sold like stocks on exchanges. The specific stocks and ETFs that you can invest in depends on the brokerage platform you use. For instance, Fidelity’s Stocks by the Slice lets you invest in fractional shares of companies and ETFs with stocks at $7000. Robinhood lets you buy shares of ETFs and stocks with a market capitalization of $25 million that trade for at least $1. Charles Schwab’s Stock Slices let you invest in any stock part of the S%P 500, but does not allow you to invest in fractional shares of ETFs. SoFi offers 43 stocks and ETFs for fractional investing. These are just a few of the many brokerage platforms that you can use to invest in fractional shares.
If you are looking to invest in fractional shares, just remember to look for a platform that doesn’t charge monthly account fees or commissions. If you are only investing a small amount of money, a commission or fee of as little as $1 can eat away at your returns faster than you think.
Now that you know what fractional shares are, and how to look for a potential platform to use to invest in these shares, here are some additional things you should know before putting down any money:
1. Fractional shares best work when they are used with index funds.
No matter what you are looking to invest in, it is important to have a diversified portfolio. However, it is difficult to build one, even if you are investing in many companies by using fractional shares. Many people want to buy portions of a stock because they want in on the popular stocks that earn a lot of money. Currently, the stocks everyone is interested in are mainly in the technology field.
Before investing in fractional shares, however, one should look to first invest in index funds. Investing in index funds gives your portfolio a good backbone, creates more diversity, and limits your risk. For instance, if you invest in an index fund that follows the S&P 500, you are investing in 500 of the largest companies within the United States concentrated across all 11 stock market sectors. After doing this, you can invest in fractional shares on top of the index funds in order to test out investing in specific stocks. For example, a good strategy might be to invest $500 in index funds for each month of the year to max out your Roth IRA. If you have extra money to invest for a month, you can use this money to invest in fractional shares of a company.
2. Know that fractional shares will not reduce the risk of you losing money
You might think that buying fractional shares limits your risk as compared to buying whole shares. However, your gains or losses are going to be the same. If the stock value drops by 25% and you decide to sell, you have still lost 25% of your money. With this being said however, fractional investing is a good strategy to use in order to limit potential losses by investing a small amount of money into expensive stocks. You are not going to build up a significant amount of money by just investing $5, however. For instance, if you invested $5 in Amazon at the beginning of 2020, you would have only had $8.60 at the end of 2020 even though Amazon shares rose by 72% last year.
3. You might have to sell your shares if you switch brokerages
Before buying fractional shares, make sure that you want to stick with your current brokerage. It is easy to transfer whole shares between accounts, but you usually have to sell off your fractional shares if you want to close out your account. Doing this could also create tax consequences…and taxes are already complicated enough.
4. A good strategy for fractional shares is dollar-cost averaging
Most people who invest on a monthly basis practice dollar-cost averaging. This strategy includes investing on a regular schedule, regardless of how the stock market is performing. Dollar cost averaging is a great way to invest over time if you have a lot of faith in a particular stock. The upside to investing a certain amount every month in a company you like is that the stock will be down some months and you will get a bargain price.
5. Long term investing pays off–fractional shares or whole shares
The largest risk associated with fractional shares is that commission-free trading and low prices make frequent buying and selling very easy. Whether or not you decide to buy fractional or whole shares, many smart investors take a buy-and-hold approach. This strategy means that they buy stocks that they want to pay-off in the long term. Even if share prices drop because of factors such as a disappointing earnings report or if the stock market crashes, these investors will hold onto their shares because they think that the company has a profitable future.
6. Fractional stocks are a much better investment than penny stocks
If you are trying to decide whether or not to invest a small amount of money in penny stocks or fractional shares, fractional shares are always the better option. Penny stocks are very cheap stocks that you can purchase for a couple of dollars or less. However, they are this cheap for as reason as many of the companies have no track record or they are in financial trouble. There are also many scams associated with penny stocks. Investing in a fractional share of a reliable company is a much smarter decision.