What are Fractional Shares?

Fractional Shares: Making Investing Attainable for Everyone 

Have you ever found yourself itching to invest in the stock market but feeling limited by the need to buy entire shares, which can cost over $1,000 per single share?

Fractional shares are here to level the playing field and make investing more accessible than ever.

So, let's break it down: what exactly are fractional shares, how do they work, and why are they worth considering? Let's dive in and find out.

What are Fractional Shares?

As the name suggests, fractional shares are when you own a fraction of a full share.

Picture having $500 to invest, and the stock (share of a company) you're eyeing is valued at $500 per share.

Traditionally, you must weigh up whether to purchase one full share with your $500.

However, the world of fractional shares introduces a level of flexibility for small scale investors.

In this case, rather than committing your entire $500 to one full share, you could own a fractional slice of a stock, representing a partial share, and invest the rest of your money into other opportunities to diversify your portfolio.

Now, let's delve into a scenario where the company's stock is valued at $1,000 per share. Your first thought might be that you cannot afford to buy a share.

With fractional shares, your $500 could translate into owning 0.5 (50%) of a share in that company.

But that’s not your only option. In an altogether different approach, instead of putting the entire $500 into one stock, you could decide to invest in multiple stocks or exchange-traded funds (ETFs).

For instance, if you choose to allocate $200 to the $1,000 stock, you will own (0.2) 20% of a share in that particular company. The remaining $300 could be distributed across other assets, enhancing the diversification of your portfolio.

To put it simply, fractional shares represent a practical way to invest a specific dollar amount in a stock, irrespective of its individual share price.

This approach not only grants you ownership in higher-value stocks without the need for the full share price but also provides the flexibility to shape your portfolio according to your risk tolerance, financial objectives, and market outlook.

Learn more:

• ‍Why people lose money on the stock market
• How to start investing in shares, your 7-step guide
• When to sell a share
• Where next for investment markets?

How Does it Work?

Fractional shares can be bought or sold in the same way as whole shares.

When an investor buys a fractional share, their investment is pooled with others to collectively own full shares.

If you own a fractional share of a stock, you have the right to a proportionate share of the benefits of holding a full share, including any gains in value and dividends distributed by the company.

The mechanics are straightforward: your investment in fractional shares is held in a custodial account in the name of a mainstream financial institution, ensuring transparency and cost-effectiveness.

What are the Benefits of Fractional Shares?

Fractional shares mirror the benefits associated with full shares, such as receiving dividends and exercising voting rights.

There are some other benefits of fractional shares, too. Let's take a closer look.

Affordability and Accessibility

Fractional shares make investing more accessible to a broader range of investors.

Some stocks have high share prices, making them too expensive for individual investors to buy full shares.

Fractional shares democratise access to these premium stocks, allowing you to invest in high-priced stocks like technology giants such as Nvidia, Microsoft, and Amazon without the need for a significant initial investment.

Diversification

One of the key benefits of fractional shares is the ability to diversify your investment portfolio with a limited amount of capital. Instead of putting your entire $500 into one stock, you can spread your investment across multiple stocks or Exchange-Traded Funds (ETFs). This diversification helps mitigate risk by not tying your fortunes to the performance of a single asset.

Dollar-Cost Averaging

Investing in fractional shares facilitates a dollar-cost averaging strategy.

Dollar cost averaging involves consistently investing a fixed dollar amount at regular intervals, regardless of the share price. This works especially well for anyone with a regular surplus, such as after you receive your regular monthly or fortnightly pay. With fractional shares, you can implement dollar-cost averaging without the constraints imposed by high share prices, in other words, waiting until you have enough to buy a single high-priced share.

This also works if you want to gradually build your position in a particular stock or ETF, you can incrementally invest without needing to buy one full share at a time.

Participation in Corporate Actions

Fractional share owners retain the benefits of owning full shares, including the ability to participate in corporate actions such as stock splits, mergers, acquisitions, and dividend reinvestment plans. This ensures that fractional share investors are not excluded from important events that impact the value of their holdings.

Educational Value

Fractional shares provide an educational opportunity for investors, especially beginners, to learn about the stock market and investment strategies. Investors can start with smaller amounts, gain hands-on experience, and gradually increase their exposure as they become more comfortable with the market.

Downsides of Fractional Shares

Despite their advantages, fractional shares do come with drawbacks.

Overdiversification

Fractional shares might encourage individual investors to overdiversify by splitting their overall investment portfolio into an ever-increasing assortment of investments. This makes it increasingly difficult to monitor and assess if all investments still are suitable to meet that investor’s needs.

Diversification is nearly always encouraged by financial professionals but taking it too far can have drawbacks.

Learn more: why you shouldn't diversify.

Liquidity

Liquidity refers to the ease with which an asset can be converted into ready cash, preferably without a significant change in price. Most shares are highly liquid, they can be purchased or sold any workday with minimal fuss or cost. At the opposite end of the spectrum, a house is usually considered an illiquid asset, as selling a house might take months and can incur substantial charges, including real estate agent and legal fees. Liquidity is one of the great advantages of investing in stock markets, but fractional shares can lack liquidity when compared with whole shares.

This means it could be more difficult to buy or sell fractional shares quickly, especially during periods of market volatility. This includes unexpected events which throw the market into turmoil, sometimes called black swan events.

Stock and ETF Availability

Not all investment platforms offering fractional shares provide access to a full range of stocks and ETFs. This limitation varies among platforms, with internationally based platforms generally offering a more extensive selection.

Platform Fees

While fractional investing platforms often tout low or no trading fees, some may charge other types of fees, such as account maintenance fees, withdrawal fees, high foreign exchange costs, low or no interest on cash held, and any number of other difficult-to-determine charges.

Delays

Some fractional investment platforms may delay executing market orders until there are sufficient orders to make a significant wholesale purchase. This could result in a disparity between the quoted and completed prices. Full shares allow immediate buying and selling without such delays.

Advanced Traders May be Put Off

Fractional share providers are really for small-scale investors, offering simplicity and accessibility. However, they usually lack advanced trading instruments, such as options or futures, which are available on the most sophisticated investment platforms.

Flawed Retail Investment

Investing in stock markets can be hard going, even for financial professionals.

A global surge in retail investors occurred during the pandemic, as people with more time on their hands – and in many cases more savings in their pocket due to being locked down – flocked to online share trading platforms. Money printed to help keep locked-down economies functioning (“quantitative easing”) also flooded through the markets, meaning nearly every asset price shot up in what might be thought of as a big night on the town. Within a couple of years, the hangover hit in the form of a bout of global inflation, and many retail investors were badly burned as the value of assets, shares included, plummeted.

Even recently, the New Zealand Herald published data showing retail investors in this country sold a range of stocks which nearly unanimously all then spiked up in value on the back of strong earnings announcements and reinvestment into artificial intelligence. In other words, the retail crowd sold just before these companies share prices surged on to new highs.

So, will increased access for low value investors help increase investment literacy, or will it just expose more investors to the downsides of the market?

Do Fractional Shares Overshadow the Problem?

Investing in tiny fractions of shares might sound good, but it may just cover up a larger problem. If someone only has a small sum to spare, the problem often isn’t how to invest it, the problem is why the person lacks funds to invest in the first place.

The best way to think about this may be by posing the following questions to the potential small investor:

1. Earnings. Are there ways you could invest in yourself first, such as courses or qualifications to boost earning power by advancing your career? If you can earn more, this should then generate more to invest.
2. Debt Repayment. Do you have debt, including buy-now-pay-later, that should be repaid before investing? Saving on debt repayments will also generate larger ongoing sums to invest.
3. Budget. Are you the boss of your own cashflows? If not, you should start with a budget. This controls how income is spent and ensures free cashflow can be prioritised into investments.
4. Safety Net. Assuming you’re just starting out, have you first built a contingency fund, and taken out appropriate personal insurance policies? Establishing such a safety net is logical before investing anything, that ensures you won’t have to dip into your investments to cover such expenses! Goals. Have you taken a good honest look at your own finances? This includes where you are now, getting clear about where you want to be, then mapping out how you’re going to get there. This is about realistic goalsetting – knowing the ‘reason why’ is the key before making any investment decision.

Related articles:

• ‍The biggest investing mistake‍
• The proven way to become wealthy‍
• What is investment risk?‍
• Investing myths, busted‍
• The number one reason your money isn’t growing

Fractional Shares for New Zealand Investors

Plenty of online share platforms facilitate fractional shares in New Zealand. International investment platforms are also available to New Zealand investors too.

The Bottom Line: Fractional Shares Pave the Way to Inclusive Investing

Fractional shares enable modest investors to overcome the traditional barriers of high share prices and limited capital, allowing them to diversify their portfolios and participate in the market with smaller amounts of money.

By owning fractional shares, investors can enjoy the benefits of holding full shares, including potential gains in value and dividends. Fractional shares also provide an educational opportunity for investors to learn and grow in their understanding of the market without having to invest such a big chunk of change.

It would be the pleasure of one of our trained professionals to help you work through any of the topics mentioned above, so get in touch today.