Since each piece of a major company can be costly, you can trade a portion of its stock via fractional shares. This way, you can build a balanced portfolio based on your available capital.
What are fractional shares?
A fractional share is a slice of a stock that is less than one full share. Fractional shares can come in several ways, including stock splits, dividend reinvestment plans, or mergers and acquisitions.
Stock splits occur when a company decides to divide its shares to lower the price and increase the overall number of shares available. While the number of shares changes, the overall valuation of the company and the value of each shareholder's stake remain the same.
Corporations often aim to create more liquidity by making a price more attractive and attainable for more investors. You might not be able to buy a stock such as Apple at $500, but you could buy it at $100, for example.
Stock splits rarely result in an even number of shares. A 4-for-3 stock split would create four shares for every three shares you might own. So, there would be a big chance you would end up with fractions of shares after the split.
Dividend Reinvestment Plans
Dividend reinvestment plans can also create fractional shares. A dividend reinvestment plan automatically uses the returns generated from dividend stocks to purchase more company shares. Such plans are not limited to whole shares, often creating fractions of shares.
Mergers and Acquisitions
Mergers & acquisitions happen all the time in the corporate world. These agreements often occur as part of growth strategies, and the companies involved may be looking to expand into a new industry, increase their market share and reach, or weaken the competition. Mergers and acquisitions may also create fractional shares since companies combine new common stock using a predetermined ratio. The ratio often results in fractional shares for shareholders.
Trading Fractional Shares
The only way to trade fractional shares is through brokerage companies, as they split whole shares intentionally to make fractional shares available to their clients. The division of shares is most often the case with high-priced stocks like Amazon or Google, but you normally have access to many more options. For this reason, fractional shares can often be the only way some people investors can trade the stock of such companies.
Why should you trade fractions of shares?
Fractional shares offer substantial benefits, including two major ones: they allow you to diversify your portfolio at a lower cost, while giving you access to a wider pool of investments.
Fractional shares offer more diversification options at a lower cost
Creating a diversified portfolio reduces trading risks since you don't use most or all of your funds in a single company or industry. And thanks to fractional shares, diversification can be less expensive too. If you want to invest $50, you could spend $10 to buy fractional shares in five different companies instead of spending your entire $50 to buy a single share of one company.
However, this doesn't imply that trading fractional shares is entirely risk-free. The low costs could make some investors spend less time on research than is necessary to make informed and smart decisions. If you are trading fractions of stock of various individual companies, this is generally riskier than buying mutual funds or index funds.
But suppose you have a sound trading strategy, and you're committed to putting in the time required to choose individual investments. In that case, the ability to trade fractional shares might give you a more viable chance of picking those investments that outperform the market than if you were restricted to trading full shares. The reason is simple: fractional shares make it possible to trade whatever company stocks you believe will likely perform best without worrying about their full-share price.
Fractional shares provide a wider pool of investments
Investors with limited money were often limited to penny stocks before. These are usually high-risk companies you've never heard of. But thanks to fractional shares, you can trade a piece of any publicly traded business, including some of the largest companies in the U.S., which trade for hundreds or thousands of dollars a share.
Fractional shares can help you create the portfolio you want but couldn't previously afford. For example, if a share costs $1,000 — which isn't unheard of — you’d need at least $1,000 just to add it to your portfolio. Want to buy more than one share? You would have to purchase in increments of $1,000 ($2,000 for two shares, $3,000 for three shares, and so on). But this isn't the case with fractional shares. Fractional trading allows you to buy the amount of stock you can afford, whether that's $5, $10, $50, $500, $1,000, or $5,000.
Because there's no company out of reach with fractional shares, you can make trading decisions not based on the amount of cash you have available but instead based on which companies you believe to have the best chance of performing well in the long run.
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