Over the past few years, we’ve seen some changes to the stock market that have made it more accessible to small investors. The rise of fractional shares is one such change. But, are fractional shares safe, and should you buy them?
Fractional shares are largely safe. Buying them is buying a small portion of whole conventional shares. Overall, they offer better diversification for small investors. They’re only dangerous if you don’t apply due diligence in your stock choices. You may also miss out on dividends on some stocks.
Are you considering getting on the fractional shares train but worried about their safety? This article will cover all the important details you need to know in that regard.
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Table of Contents
What Are Fractional Shares?
Fractional shares are small slices of a stock. In the past, you had to pay the full price for a share when investing in any stock. This meant that small investors couldn’t afford to buy a single stock in companies like Google and Amazon, with stock prices between $2,000 and $4,000 per share, never mind others like Berkshire Hathaway Inc. with stock prices above $300,000.
However, with fractional shares, investors can now buy a small fraction of the stock. So, you can now own 0.5% of a single Google or Amazon stock. This has made investing easier for many people.
Fractional shares are also beneficial to people that can buy full shares. They no longer have to buy a lesser number of shares because of fractions in the stock price. Assuming you have $100,000 and want to buy ten shares for a stock worth $10,025. In the past, you’d have only bought nine shares. With the rise of fractional shares today, you can get 9.97 stocks of the company.
How Are Fractional Shares Produced?
Since companies don’t sell 0.25% (or 5%, 10%, etc.) of shares, where do these fractions come from? How are brokers able to offer them?
In the simplest terms, brokers (or market makers) buy full shares when there’s an order and then give customers the fractions they want while keeping records of who has what percentage. So, the fractional share you own is your portion of the cake.
How Does Fractional Shares Investing Work?
To buy fractional shares, the first step is to find a broker that offers the product. Once you’ve signed up and funded your account, find the company you’d like to buy shares of.
On the order page, input the dollar amount you’d like to invest in the company, and you’ll automatically see what fraction of a single stock you’ll get. If you’re happy with everything, send the order, and you’re done.
If you make profits in the future and want to cash in your investment, simply open a sell order.
Keep in mind that you can only buy fractional shares of stocks in the American market in many cases. Stocks in the European and Asian markets may not provide you with the option for fractional orders for now. Nevertheless, some brokers have started adding foreign stocks, and as the wider industry adopts the practice, investors would be able to buy fractional shares from anywhere very soon.
Are Fractional Shares Safe or Dangerous?
Fractional shares are generally safe. You’re buying into a company’s stock, so as long as the company continues to perform for investors, your investment is safe.
Why Should You Embrace Fractional Shares?
Some of the benefits of fractional shares include:
Better Diversification
In the past, the only option you had as an investor without a lot of money was to put your investments in one or two companies you could afford the shares of or take the high-risk approach of investing in penny stocks.
However, with fractional shares today, you can invest in as many big companies in the US as you want, even if you have less than $1,000 to invest.
This means you can enjoy a more diversified portfolio overall. The success of your investment will not depend on one company’s performance. You also won’t make investment decisions based on which stocks you can afford. Rather, you can focus on choosing companies that have the best chance of performance overall.
No Barriers
One of the main advantages of fractional shares is that they have lifted the limit on who can become an investor. Anyone who can afford some money and access a smartphone can start building a portfolio in minutes. It’s one of the reasons why more young people are picking up investing.
Better Control
Fractional shares give you better control over your investments. You can make a specific stock 1-10% of your portfolio in seconds, and you don’t need any elaborate processes to rebalance or liquidate a portfolio. You have freedom over the investment strategy you choose to adopt.
Why Fractional Shares May Be Dangerous?
Despite all the advantages we covered, you should know that it’s not all rosy with fractional shares. It may not be any more dangerous than other forms of investing, but they do come with a few disadvantages that you should keep in mind.
Reckless Investing
With no barriers to investing anymore, new entrants to the market may be reckless in their approach and lose money in the process.
Some misinterpret high stock prices as a sign of valuable investment, but that isn’t always the case. Stocks with inflated prices may end up underperforming.
Missing Out on Dividends
If you own a small fraction of a share, the broker will most likely keep your dividend. The few cents may not matter, but over time they add up. The total dividend lost may also form a large chunk of the returns you are due from a particular stock.
Exorbitant Fees
Many platforms that offer fractional shares operate the zero-commissions model. However, some may have other fees that can mount pretty quickly if you buy and sell fractional shares frequently.
If you choose a broker that charges commissions, your expenses will most certainly skyrocket. You may spend more time trying to make back the fees before you start making profits.
Not Offered Universally
While there are quite a few brokers that allow customers to buy or hold fractional shares, many others don’t. You may have to spend some time finding a new broker if you intend to delve into fractional shares.
Transferring your assets to a new broker may also be impractical. With most of them, you have to sell the shares and then take the cash elsewhere. This may have some tax implications and other hidden costs that can erode any profits.
Should Fractional Shares Form the Crux of Your Investing?
Before you start to invest in fractional shares, it’s best to ensure you’re in the right financial position. Ideally, you should have accomplished the following:
- Cleared all your high-interest debts.
- Put together an emergency fund.
- Your tax-advantaged accounts are fully funded.
- You’re investing in a 401K program, always matching the full contribution from your employer.
These will be more beneficial in the long run compared to owning fractional shares in individual stocks. Some experts also insist on ensuring you have a core base of investment in index funds before getting started with fractional or full shares.
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Conclusion
Fractional shares offer you an excellent way of buying stocks in companies you’re interested in without worrying about affordability. You can buy as much or as little of any company’s stocks. However, as with all types of investment, you need to exercise caution with your choices.
Check to confirm that you’ve covered your financial base first before going this route. Do your research on companies and avoid making rash decisions, and you should be fine.
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