Generally, when the investors plan to invest in stocks, they are thinking of a full share. If they are eyeing the US stocks, the higher cost of these stocks prevents the investors from putting their hard-earned money into it. This is due to one of the following reasons:
- The investors lack the capital needed to diversify their portfolios.
- The investors aren’t willing to invest their entire savings in a single company.
Do you know there is a way to invest in US blue-chip stocks by paying only a part of the price of the whole share? This is possible with the help of fractional shares. Let’s understand this concept first and then we will discuss the things you should know before buying fractional shares.
What Is a Fractional Share?
Let’s compare the share of a company with a whole pie. We can split the pie into many pieces and each customer will get one piece of the pie.
Fractional shares are similar to slices of a pie. The stock of a company can be split into many fractions and you can pick only one of the parts of the whole share. Eventually, you will gain profits from the appreciation of the fraction purchased by you.
Therefore, lack of capital is no longer a reason to avoid buying shares of a company as you can invest in fractional shares. These types of shares have gained popularity in the last few years due to the advancement in the field of brokerage technology.
With the help of fractional shares, you can buy expensive securities and even diversify your portfolio even with limited capital. It allows you to invest in stocks with the amount that fits your budget. You can even start investing with an amount as low as $1.
You Can Diversify Your Portfolio With Fractional Shares
The most famous stocks are usually expensive due to high demand. Thus, if you want to invest in these expensive shares, it can burn a hole in your pocket. That’s where fractional shares come into the picture. They allow you to invest a part of your capital in each of the share companies of your choice.
Let’s say that you have kept $5000 aside for investing in stocks. You can invest $500 in 10 different companies. This helps you diversify your investment and distribute the risk.
What Is the Process of Creating Fractional Shares?
The process of creating fractional shares is one of the important things you should know before buying fractional shares. Fractional shares are created by the companies in the form of stock splits, mergers, and acquisitions, etc. Many brokerage firms allow you to invest in fractional shares.
Let’s take a look at the ways fractional shares are created:
- Mergers and Acquisitions
Fractional shares can be created due to mergers and acquisitions as the companies merge to create new stocks with a predetermined ratio.
- Dividend Reinvestment Plans
DRIP or Dividend Reinvestment Plan allows the investors to utilize the dividend payouts to buy the same shares. DRIPs are offered by brokerage firms and some companies.
But in some cases, the amount received as a dividend is not sufficient to buy a full share. Such a scenario leads to the creation of fractional shares.
- Stock Splits
A stock split or stock divide increases the number of shares of a company. It causes a decrease in the market price of individual shares but the total market capitalization of the company remains the same.
The stock split usually produces an odd number of shares. Let’s say that a company XYZ announces a stock split of 3-for-2. This means that it would create 3 shares for every 2 shares owned by an investor.
In this scenario, the investors holding an odd number of shares will have fractional shares after the split.
What Are the Advantages of Using Fractional Shares?
The advantages of fractional shares are one of the things you must know before buying fractional shares.
- You can invest with limited resources
If you have limited capital, it becomes difficult to invest in companies of your choice. But with the help of fractional shares, you can buy your favorite stocks. You don’t need to save up to be able to buy a whole share.
For example, if the price of your favorite stock is $500, you don’t need $500 to buy the share. You can buy a fraction of the share.
- You get the option of diversification
With the help of fractional shares, you get the opportunity to diversify your portfolio by investing in different types of companies.
Diversification of portfolios helps in reducing the risk associated with the volatility in the market and is a good option for investors. It also helps in maximizing your profits in the long run.
- It is a feasible option for a meeting investor
As fractional investing doesn’t require a lot of capital, to begin with, it is a good option for a beginner investor. If you are new to the market, investing in these fractional shares is a good way to maximize your returns.
Let’s say you have a capital of $4000, you can invest $400 in 10 different companies to distribute the risk evenly.
- It offers flexibility to Investors
As an investor, if you are planning to buy whole shares, you need to set aside enough capital to purchase them at the targeted price.
With the help of fractional investing, you can set a predetermined dollar amount that you wish to purchase and the shares will be allotted to you accordingly.
Let’s say you are planning to invest in $5000 worth of stocks of company X, with the price of each share $100.2. You will be eligible to buy the smallest fractional share with $0.01. Fractional shares allow you to invest in stocks with high market prices per share.
What Are the Limitations of Fractional Shares?
Along with advantages, fractional investing also comes with a few limitations some of which are as follows:
- It is difficult to trade fractional shares
In some cases, the time needed to buy fractional shares is more than buying a whole share.
Along with this, the tax assessments related to fractional shares may give rise to unwarranted complications.
- Inflation in Prices
The price of expensive stocks might become inflated as fractional investing allows retail investors to purchase the shares.
In the long run, investment in companies with inflated share prices can turn out to be a bad decision.
Summing Up
Even with a few limitations, the benefits offered by fractional investing make it a good option for investors. This type of investing has gained popularity over the few years and continues to be an investment option for beginners as well as experienced investors.
In this blog, we have covered all the things you should know before buying fractional shares. So, if you are planning to invest in fractional shares, find out which broker or online advisory platform offers this functionality.
