As the name would suggest, a fractional share is a fraction, or portion, of a full share. These have lowered the entry bar for those interested in the stock market but can’t afford to pay the total cost for whole shares. But is this approach more expensive?
Fractional shares cost more overall if traded on brokerages where commissions are charged per trade and regulatory fees are not waived. The bid and offer price offered by market makers for fractional shares may also differ from the prices offered on whole shares.
In this article, I’ll look at all the areas where fractional shares may be more expensive than buying whole shares from standard stock brokerages and how you can avoid this problem as an investor.
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Table of Contents
What Makes Fractional Shares Cost More?
Fractional shares are likely to cost more than whole shares because so many factors come into play to convert shares into 10,000 or 100,000 fractions.
Technology has made the splitting and management of each fraction easy, but these systems are not free to use. Providers have to pay to maintain these technologies, and the costs are invariably transferred to clients in different ways, including:
- Trading commissions
- Broker fees
- Differences in pricing
- Regulatory charges
- Tax costs
Let’s take a closer look at each of these and how they can affect the cost of fractional shares.
Trading Commissions
Some brokers charge commissions to open or close fractional shares positions. These costs are tiny in isolation, but many investors open and close lots of positions per trading year, and those engaging in fractional shares day trading can transact thousands of times.
This means commissions can amount to very significant sums over a trading year for any fractional shares investors.
Broker Fees
Some brokers have a fee structure to pay specific sums to own a fractional shares portfolio. The fee may be charged monthly or yearly and can be as little as $10 per month or as high as $200 or more per year.
In other cases, they may charge a percentage of the trading account. Regardless of the approach adopted, these sums can add up if you have a long-term view of your fractional shares trading.
Differences In Pricing
In addition to the commissions and fees, many market makers offer pricing that includes a slight markup compared to prices quoted for whole shares.
This is how they generate the funds used in Payment for Order Flow to brokers. Many brokers make their profits via these markups.
Again, it’s a tiny difference when you look at a single order. However, with some brokers making up to $70m in a year from these payments (across all traded instruments), there’s no denying that they make decent money from the pricing difference for fractional shares.
The market-makers are obligated to match the best offers available on exchanges, but they are not obligated to do better. This means that they’re always likely to stay within what’s allowed while adding markups—especially on fractional shares trades.
Regulatory Charges
Fractional shares traders may also have to pay some regulatory fees, especially when selling shares. Two such charges are the Regulatory Transaction Fee and the Trading Activity Fee.
Regulatory Transaction Fee
The Financial Industry Regulatory Authority (FINRA) is legally required to pay a regulatory transaction fee to the Securities and Exchange Commission (SEC).
This fee is important because it covers the cost incurred by the government in carrying out its role as the regulator and supervisor of the securities markets and professionals operating in it. The amount is not fixed, as it is reviewed from time to time.
FINRA generates the fee by passing it on to all members—which includes brokers offering fractional shares trading. The brokers pass on their share of this cost to customers.
Some brokers only enforce this fee for customers who sell positions worth more than a notional value of $500.
Trading Activity Fee
FINRA also charges fees from brokerage firms to cover the overall cost of their operations. Think of this as a “local” fee, while the Regulatory Transaction Fee is a federal fee.
Most brokers pass this fee down to the customers, but they operate different payment brackets.
Generally, most of the popular brokers charge higher fees from people with more orders executed. All fees are rounded to the nearest penny.
Tax Costs
Most brokers don’t allow transferring of fractional shares. To transfer your assets out from a specific broker to another, the shares must first be sold and converted to cash.
The cash can then be transferred out of your current brokerage to the new one. This conversion and transfer process can have some tax consequences—especially if you’re selling your fractional shares at a profit.
Why It’s Worth It to Buy Fractional Shares?
With all of the above, you’re probably wondering if fractional shares are worth it in the first place or if you’re better off buying stocks you can afford from exchanges. To help you decide, you should compare the expensive side of fractional trading to its benefits.
In general, it makes sense to whether the expenses you can incur on fractional shares if you consider the following:
Faster and Easier Investing
As you already know, fractional investing allows almost anyone to buy specific dollar amounts of any shares.
So, if you’ve got $2,000 to invest and want to buy some stocks, you don’t have to only look at cheap and unpopular companies.
You can choose to buy the top 20 most capped stocks on the U.S exchange, investing $100 on each of them. It won’t matter that the total share price for some of them is as high as $3,000 per share or more.
You can invest what you have right away and start making money from a more robust portfolio right from the comfort of your home on a smartphone.
Higher ROI Possibility
Many fractional share investors don’t just buy $100 worth of Apple shares and hold it for five years in hopes for continued appreciation. Instead, they actively trade the micro-movements of specific stocks over a trading week or month, backed by some leverage.
Leverage has its downsides, but savvy traders can use it to buy and sell fractional shares to make more money than standard buy-and-hold traders.
The income gained is often more than enough to offset the costs of trading fractional shares.
Think about a situation where you’re able to generate up to 50% returns on your $2000 with some leverage after commissions and any fees have been deducted.
How many standard stock portfolios can generate up to 50% returns per year? Hint: not many.
How To Reduce Your Expenses as a Fractional Shares Investor?
You’ve seen some of the ways fractional shares investing can be more expensive. But is there a way to keep costs down to the barest minimum?
Choose Commission-Free Brokers
There are many brokers offering commission-free trading for fractional shares investors. Go over the terms and conditions for a few of them and choose an option that appeals to you the most.
Keep in mind that all brokers will make their money from customers in one way or another.
So, commission-free brokers may offer slightly worse pricing as they sell the traffic to market-makers that will pay the most rebates. They may also charge monthly fees for special accounts.
Still, avoiding commissions can significantly reduce the overall cost of trading.
Avoid Features You Don’t Need
As I stated above, some brokers will market special accounts with certain benefits to lure customers away from free or standard accounts.
The average investor doesn’t need these features. Suppose a standard account on the brokerage covers everything you need. In that case, there’s no need to pay monthly fees for “more sophisticated charting software” or even important features like leverage.
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Conclusion
Fractional shares cost more if you’re carrying out transactions on a broker that charges commissions or offering heavily marked-up prices. By sticking with popular commission-free brokers and only using services you need, you can keep the expenses down.
Choosing the right broker will also remove the need to move across brokers and trigger some tax implications.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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