What is a Fractional Share?
A fractional share can be defined as the portion of stock which is less than one complete share that cannot be bought from the market directly and is a result of bonus shares, stock splits, mergers or acquisitions of companies, or dividend reinvestment plans and cannot be sold directly in the market.
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Explanation
The company’s capital is divided into small parts known as shares. Sometimes these shares are also split into small pieces known as fractional ones. These shares cannot be purchased directly from the market nor sold; the only way to sell these shares is through brokerage firms’ help. Selling such shares takes ample time; brokerage firms usually combine multiple fractional shares into a single unit share and then sell shares in the market. Sometimes brokerage firms purposefully split high-value shares into fractions to sell them to their clients. This is the only way for small retail investorsRetail InvestorsA retail investor is a non-professional individual investor who tends to invest a small sum in the equities, bonds, mutual funds, exchange-traded funds, and other baskets of securities. They often take the services of online or traditional brokerage firms or advisors for investment decision-making.read more to invest in big companies where the price of the share is too high.
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How to Invest in Fractional Share?
These shares are not available for trading in the open market directly. These can only be purchased or sold through significant brokerage firms; for example, a retail investor is willing to invest in substantial companies with high share prices in the market with high value for speedy growth but with lower funds. Still, he can’t buy the full share due to insufficient funds. In this case, he can approach a brokerage firm that intentionally splits the share of such big companies into fractions and sells them at a reasonable lower price so that such small investors can invest in these companies and buy the fractional share. In this way, an investor can invest in these shares with limited funds.
How Does it Work?
Fractional shares are an essential innovation that takes place in online investing. Whenever an investor thinks of investing in shares, it is generally invested in one total equity share, but under the concept of a fractional share, a part of a slice of a share can be purchased when investing in a large company. Sometimes even a single share costs very high for an investor. In such a scenario, this share comes into practice. Suppose XYZ company’s shares are selling for $200. Under this concept, a part of XYZ’s share can be bought at, say, one-fourth of the share, valued at $50. The higher the value of the stock, the more will be the value of fractional shares. They might not be as valuable or necessary for the low value stocksValue StocksValue Stock is one that has the potential of selling at a higher price but due to the company’s adverse condition in the market, the stock is trading at a lower price than its actual worth based on its earnings, dividend, or sales.read more as investors may invest in such shares directly.
Reasons to Buy Fractional Shares
- The first and foremost reason to buy such shares is the limitation of a fund with the investor.
- They are used as part of the dividend reinvestment planDividend Reinvestment PlanThe dividend reinvestment plan is the option chosen by the investor to reinvest the amount of cash dividend payable by the company in new shares of the underlying securities on the date of dividend payment.read more. Since dividendDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more does not provide enough money to buy a share, a fractional share turns out to be a good option. Here since broker intervention is not there, it also costs low.
- They enable anyone to trade with the money they have. Since high entry costs can be a difficult barrier, it makes entry into the market with shorter funds
- Also, technology is a big boom in this share. Traditionally, breaking up big shares into smaller chunks was a difficult task, but with the growing technology and introduction of fractional shares, now working up with dividing the shares into a lower value is an easy task.
- One of the positive reasons to buy these shares is that they are meant for risk-averse investors and allow them to test the market in their initial learning.
Benefits
- Diversification: An investor can diversify its portfolioDiversify Its PortfolioPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio.read more with multiple stocks when he has traded with fractional shares. Even if one chooses the cheaper stock, he can pick up more than ten or more of such stocks to make a more significant portfolio and diversify the loss and profit. Diversification helps in lowering the risk while increasing the profit potential in the long term.
- Flexibility: They provide flexibility so that not all your money needs to be invested. Accordingly, investors may invest in multiple such stocks to enlarge diversity in a portfolio.
- Money can be Used All Time: It helps the buyer use all their money at all times. For example, if an investor wishes to buy a stock of ABC inc. Having a share price of $400 but only $50, such an investor can purchase fractional shares of ABC Inc. Accordingly, investors need not wait until he has enough money to buy the one total share of a particular stock.
- Excellent Opportunity for Newer Investor: For the newbie investor, investing in these shares can be an excellent start to learning and exploring with less risk. The newer investor can apply his strategies and learnings within the market.
Limitations
One of the significant drawbacks of fractional shares is the difficulty of trading, i.e., the only way to trade in such shares is through a major brokerage firm. If the brokerage firm does not find many investors for a single stock, which is fractionated, it might end up denying the allotment of these shares. Also, the time to fractionate the share is still higher than purchasing a single lot share. Moreover, the tax assessment of trading in these shares becomes complex.
Conclusion
Trading in fractional shares is possible with a small number of monetary funds. These trades are an excellent opportunity for small and new investors as they provide more returns with less risk. Also, it helps to diversify an investor’s portfolio. One of the significant drawbacks of these shares is the difficulty of trading, i.e., the only way to trade in fractional shares is through the major brokerage firms. Share splits may not always result in an even number of remaining stocks.
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