What is a Fractional Share?
Fractional share can be defined as the portion of stock which is less than one complete share which 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.
Explanation
The company’s capital is divided into small parts known as shares and sometimes these shares are also split up in small parts known as fractional shares. These shares cannot be purchased directly from the market either can be sold, the only way to sell these shares is through with the help of brokerage firms. Selling of 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 with the motive of selling them to their clients. This is the only way for small retail investors to invest in big companies where the price of the share is too high.
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 major brokerage firms say, for example, there is a retail investor willing to invest in major companies having high share price in the market with high value for speedy growth but has lower funds but due to insufficiency of funds he can’t buy the full share. In this case, he can approach a brokerage firm which 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 important innovation that takes place in online investing. Whenever an investor thinks of investing in shares, it is generally invested in one complete equity share but under the concept of a fractional share, a part of a slice of share can be purchased when investing in a large company. Sometimes even a single share cost very high for an investor, in such a scenario this share comes into practice. Suppose XYZ company’s share is selling at a price of $200. Under this concept, a part of XYZ’s share can be bought at say, one-fourth of share which will be valued at $50. Higher the value of the stock, more will be the value of fractional shares. They might not be as valuable or important for the low value stocks 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 plan. Since dividend does not provide enough money to buy a share, fractional share turns out to be a good option. Here since broker intervention is not there it also costs low.
- They enables 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 in lower value is an easy task.
- One of the positive reasons to buy these shares is that these are meant for risk-averse investors and give them the opportunity to test the market in their initial learning.
Benefits
- Diversification: An investor can diversify its portfolio with multiple stocks when he has traded with fractional shares. Even if one chooses the cheaper stock, he can pick up more than 10 or more of such stocks to make a bigger portfolio and diversify the loss as well as profit. Diversification helps in lowering the risk while increasing the profit potential in the long term.
- Flexibility: They provide flexibility in a way that not all of 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 to use all of its money at all times. For example, if an investor wishes to buy a stock of ABC inc. having a share price of $400 but he has only 50$, such an investor can buy fractional shares of ABC Inc. Accordingly, investors need not wait until he has enough money to buy the one complete share of a particular stock.
- Excellent Opportunity for Newer Investor: For the newbie investor, investing in these shares can be a good start to learn and explore more with lesser risk. The newer investor can apply his strategies and learnings within the market.
Limitations
One of the major drawbacks of fractional shares is the difficulty of trading i.e. 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 taken in fractionating 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. Also, it helps to diversify an investor’s portfolio. Share split may not always result in an even number of remaining stocks. These trades are a good opportunity for small and new investors as they provide more returns with lesser less risk. One of the major drawbacks of these shares is the difficulty of trading i.e. only way to trade in fractional shares is through the major brokerage firms.
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