Pros & Cons Of Fractional Share Investing

Pros & Cons Of Fractional Share Investing

Pros & Cons Of Fractional Share Investing
Reading Time: 5 mins

With a market capitalization (or total stock value) of over $600 billion, Warren Buffet’s Berkshire Hathaway is the highest-priced stock in the world. You’ll need well over half a million loonies to own a whole Berkshire Hathaway stock, which is more than what the average Canadian has in retirement savings.

A recent CIBC poll revealed that Canadians have saved an average of $184,000 in their retirement accounts. Based on this average, even when you empty your retirement kitty, you’d still be $250,000 shy of raising enough funds for a single Berkshire Hathaway stock. This is where fractional share investing comes in.

As the name suggests, this concept allows you to purchase a fraction of a share for the dollar amount you’re willing to spend. For instance, if you’re willing to spend your retirement savings of say, $184,000 on Berkshire Hathaway, you’ll own 0.42 or 42% of a share.

Fractional share investing allows you to own portions of some of the most valuable stocks in the market that would otherwise be out of your reach. If you’re considering a portion of highly priced stocks, this write-up is for you.

What Is a Fractional Share?

Ownership of a company is divided into stocks, each of which represents a portion of the company’s worth. Purchasing a company’s stock is buying a portion of ownership in the company. Initially, if you wanted to add the shares of a certain company to your portfolio, you could only purchase whole shares at the current market price.

Due to this limitation, highly priced stocks were reserved for elite investors with deep pockets. Today, thanks to fractional shares, you can own a piece of some of the expensively priced shares in the stock market. A fractional share refers to a portion of one full share. It is what you get when you buy a slice of a full share.

When you pay $75 for a stock valued at $250, what you get is 0.30, or 30%, of the full share. Although major exchanges still limit investors to purchasing one or more whole shares, some reputable brokerage agencies are setting the pace for fractional share investing, in which individuals can own portions of their favorite stock for as little as less than a dollar. In fact, buying partial shares of stock is a common investment practice among individuals with limited capital.

The amount of dividends you get from fractional shares is directly proportional to the size of the share you own. For instance, if there’s a dividend payout of $5 on an $800-per-share stock and you invested only $200, you’ll get dividends of 0.25, or 25%, of $5, which is roughly $1.25.

How Much Do Fractional Shares Cost?

There’s no definite price tag on fractional shares. The amount varies depending on the cost of the stock. Simply put, the price of a fractional share depends on the value of a whole share and the size of the slice you are looking to purchase.

For instance, if you want to purchase 0.3, or 30%, of a stock valued at $300, the cost of that fractional share will be $90. Another investor who wants to purchase 0.2, or 20%, of the same stock will pay $60.

Usually, brokerages set the minimum price for a fractional share of a particular stock. For some shares, the least you can invest on a fractional share is $5, whereas others accept as little as less than a dollar.

Why Invest in Fractional Shares?

There are several reasons to invest in fractional shares. The most common reason is the lack of sufficient capital to purchase a full share. With this dollar-based investing strategy, you don’t have to be a big shot investor to buy and trade expensive stocks.

Based on the minimum investment a brokerage permits, you could own a piece of that lucrative stock you’ve been eyeing. If you’re a beginner in the stock market and want to manage your risks as you start out, fractional shares could be your ideal ticket in. Fractional share investing enables beginner traders to get started with limited capital and thus lower their risks.

Another reason to invest in fractional shares is if you want to diversify your portfolio and reduce the risk of putting all your investments under one stock. If you invest in multiple fractional shares of different stocks, when one stock plunges, the rest of your investments can be shielded from dramatic market moves.

Lastly, fractional share investing is ideal if you want to practice dollar-cost averaging, or investing a fixed amount of money regularly on stock or ETFs without regard to how many shares you own, instead focusing on the total dollar value of your investment.

The other benefits and downsides of fractional shares to consider are discussed below.

1. Benefits of Fractional Shares

Fractional shares have lifted the barrier of entry into the stock market, enabling average investors with limited capital to venture in. With fractional share investing, you don’t have to raise $3,293 to buy Amazon’s stock. For a paltry $100, you can own 0.03, or 3%, of an Amazon share and still receive dividends for it.

Fractional shares give you control over the amount of money you can use to build your portfolio. Usually, the price of the stock you are looking to buy dictates how much you will spend on the shares. However, fractional share investing allows you to decide how much you are going to spend on a particular stock.

Through fractional investing, investors with limited capital can diversify their portfolios in the same way as their counterparts with huge balances. It allows you to purchase portions of stocks you want, regardless of the share price. For example, instead of investing $3,293 on a single Amazon stock, you can purchase fractions of multiple stocks and have a diversified portfolio.

2. Downsides of Fractional Shares

There’s a limited selection of stocks available for fractional share investing. Before getting started in fractional investing, understand that not every stock traded on major exchanges is available for fractional share investing. This means that you will have a limited selection of stocks to choose from.

Another downside to investing in fractional shares is the hassle of liquidating them. Unlike whole shares, fractional shares are a bit difficult to liquidate immediately. Often, brokers wait until fractional shares make up a full share to purchase them. This can be slow and dispiriting, especially if you want to liquidate your investment immediately. Also, if you hold fractional shares that are not in high demand, the wait to liquidate could be longer.

Some brokerages don’t allow you to transfer fractional shares to other brokers. They instead facilitate the transfer of full shares and sell fractional shares to give you cash. This could be an unnecessary inconvenience.

Among the perks of owning a company’s stock is the right to vote on company matters. Some brokerages don’t allow investors with less than a full share to vote. If you pride yourself in contributing to the running of the companies you invest in, you’ll be disappointed when you have fractional shares.

What Types of Brokerages Offer Fractional Shares?

Major stock exchanges don’t allow fractional share investing. Even so, in Canada, few reputable brokerages allow individuals to purchase fractional shares and receive dividends for them. WealthSimple is the first Canadian investment broker to offer fractional share investing.

Robinhood rolled out fractional share investing in 2019 and is now among the world’s leading brokerages offering fractional shares. Other reputable fractional share investing brokerages include Charles Schwab, M1 Finance, Fidelity, InteractiveBrokers, Royal Bank of Canada, Toronto Dominion Bank and Canadian National Railway.

Conclusion & Recommendations

Fractional shares have helped erase the perception that you need thousands of dollars to get started in the stock market. As established by the investment experts at MoneyWizard.ca, with as little as $5, or even less in some brokerages, you can own $5 worth of stock and wait for your investment to compound over time.

If you’re a risk-averse investor, fractional investing allows you to choose the size of your investment by dollar amount instead of shares. It allows you to start small and diversify your stock portfolio with limited capital. At MoneyWizard.ca, we’ll help optimize your future with fractional share investing. Don’t wait; start investing now.

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