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In the past, investing in stocks and exchange traded funds was hard.
In order to invest, you needed to figure out how much buying a share was going to cost you and then do the math to see how many shares you could buy with the money you had.
In recent years, brokers have started to allow for fractional share investing.
This allows you to buy partial shares of stock, making it much easier to invest.
But how does fractional share investing work?
What are the advantages and drawbacks?
Is it right for everyone?
In this post I cover all the ins and outs fractional shares and show you why you should consider investing this way, especially if you don’t have a lot of money to invest.
Table of Contents
How Does Fractional Share Investing Work
What Are Fractional Shares?
Fractional shares are simply partial shares of stock.
With mutual funds, you could always purchase fractions of a share.
But with individual stocks, you needed to buy whole shares.
That was until a few years ago.
Now many brokers allow you to purchase fractions of shares of stocks.
The main benefit is making it more affordable to buy stocks with high share prices.
For example, Amazon trades at $3,000 for a full share of stock.
That is a lot of money to invest.
Before fractional investing became popular, you had to have this amount of money to invest.
But now, you can have smaller amounts of money and still invest.
If you have $500, you can buy 0.1667 shares of stock.
In other words, it allows you to start investing without the need for a lot of investable cash.
Also, in the past, if there was reverse stock splits or corporate actions, you might end up with fractional shares of stocks.
Your brokerage account would simply sell the partial shares and credit you with the cash difference since partial shares were not possible.
Now, you might be able to keep these partial shares depending on your broker.
Now that you know a little more about what fractional shares are, let’s dig into how they are a good idea for most investors.
How Do You Buy Fractional Shares?
You buy partial shares just like you would any other investment.
The biggest difference is instead of saying you want to buy a certain number of shares, you input the amount of money you want to invest.
Your broker will then do the math to tell you how many shares you are going to buy.
For example, if you are looking to by a $30 stock and you have $250 to invest, you will enter the $250 as the buy amount and your broker will tell you that you will buy 8.33 shares.
- Read now: See the power of investing $250 a month
Can You Sell Fractional Shares?
Yes, you can sell fractional shares.
If you want to sell all of your shares, you can usually just click the button on the trading page that says to sell all shares.
On the other hand, if you want to sell a certain number of shares, say 1.450, then you enter this amount in the shares to sell field.
Do You Earn Dividends With Fractional Shares?
You do earn dividends when you own fractional shares.
The catch here though is you only earn a partial amount of the dividend payouts.
For example, if the dividend is $0.25 a share and you own ½ shares, your dividend will be $0.125 and not $0.25.
This doesn’t mean you are getting cheated out of dividend payments, it just means since you own a partial share, you earn the corresponding partial dividend.
The good news is, just like with owning whole shares, you can elect to take part in dividend reinvestment plans.
So you could either take the cash for the dividend you earn or you can reinvest it and buy more partial shares of stock.
Ability To Have A Diversified Portfolio
It’s important to understand that fractional share purchases lower your overall risk thanks to being able to diversify your portfolio.
Going back to the idea of high stock prices, if you had $1,000 to invest and a company was trading for this amount, you would buy one full share of stock.
All your money would be tied up in this one company, which is very risky.
But if you buy a fraction of a share, say a half share for $500, you still have $500 to invest in other stocks.
This allows you to lower the overall risk of your investment portfolio because you are spreading your money between different investments.
For new investors, this is critical to long term success.
- Read now: See the importance of diversifying your portfolio
- Read now: Learn the difference between asset allocation vs. diversification
Advantages And Drawbacks
There are many pros and cons of fractional shares.
In fact, I go into great detail in the post below.
Here is a quick run through of the biggest things to consider.
Invest in companies with high share price. Being able to buy fractions of a share allows you to invest in higher priced stocks.
Easier to reach desired asset allocation. You can control where your money goes more easily, allowing you to hit your asset allocation goal.
Invest by dollar amount. Simply pick the amount of money you have and invest it as opposed to doing the math and figuring out how many shares you can buy.
Makes dollar-cost averaging a lot simpler. By fractional share trading of stocks and ETFs, it makes it a lot easier to dollar cost average small amounts of money over time.
Higher fees. If your broker charges a trading fee, the more trades you make, the additional fees you pay.
Not offered by all brokers. Not every brokerage firm allows you to buy partial shares of stocks and exchange traded funds.
More tax lots. Buying more often creates more tax lots to deal with at tax time when you sell. The good news is most brokers will summarize your gains and losses for you.
What Brokers Allow For Fractional Share Investing?
Most brokers allow you to buy partial shares of stocks.
This includes Charles Schwab, Fidelity, Interactive Brokers, and M1 Finance.
In most cases, you can trade for free.
M1 Finance broke the chains when it was the first to offer free stock trading. Even as other brokers come onto the scene, M1 Finance is one of the best choices for DIY investors looking to invest.
Some brokers also allow you to buy fractional shares of exchange traded funds as well.
However, not many allow for partial ETF trades, so you need to confirm with your broker.
The good news is that more and more are starting to offer this, so finding a willing broker shouldn’t be too difficult.
- Read now: Learn more about what ETFs are
There is the answer to how does fractional share investing work.
Know that fractional shares are a great way for individual investors to start building wealth in the stock market even when they don’t have enough money to buy expensive stocks.
It’s also a great way to invest when you don’t have a lot of money to invest.
While this investing strategy can make tax time a little more complicated with more tax lots to deal with, this shouldn’t be a reason you avoid it.
The benefits far outweigh the drawbacks.
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I have over 15 years experience in the financial services industry and 20 years investing in the stock market. I have both my undergrad and graduate degrees in Finance, and am FINRA Series 65 licensed and have a Certificate in Financial Planning.
Visit my About Me page to learn more about me and why I am your trusted personal finance expert.