Fractional shares is a popular feature offered by different brokerages. Fractional shares have been used by different companies such as 3M in a so-called Dividend Reinvestment Plan (DRIP).
When owning fractional shares the shareholder is entitled to receive dividends in proportion to the fractional shares owned. Fractionals shares are offered by both brokerages and dividend-paying companies offering dividend reinvestment plans (DRIP).
Fractional shares have gotten very popular on American brokerages. However, only recently been added to the European market. So what is the fuzz about fractional shares?
What is Fractional Shares?
Fractional shares are fractions of ownership in an equity. Most traditional brokerages only allows for integer shares ownership. The fractional shares can occur from multiple events such as stock splits, mergers, and acquisitions or dividend reinvestment plans (DRIPs).
In the hypothetical event that Amazon were to make a 10:1 stock split, shareholders would receive 10 shares for each single share owned. However, such events do not create fractional shares. However, any stock split ratio is possible.
A stock split which can generate fractional shares would be as the following example. In the hypothetical event that Amazon were to make a 3:2 stock split, each investor would convert each 2 stocks into 3 stocks. This means 15 shares of Amazon would be converted to 22,5 shares. In essence, you will have 22 full shares, and 0,5 fractional shares.
A fractional shares is a fractional interest in a pool of integer shares. This is how brokerages and DRIPs work. The pool will pass along your share of the dividend (typically brokerages) or use it to buy more shares (typically DRIPs).
There are different conditions based on the brokerage/DRIP program which is followed in terms of the methods used for dividend repayment. Typically when using a brokerage, the dividend is paid to the free fund accounts. However, DRIP programs reinvest the dividends to acquire more shares. Typically, DRIP programs also allow for ownership of fractional shares, whereas brokerages do not.
What Is The Benefits Of Fractional Shares?
Fractional shares come with a number of benefits. The benefits do impact every investor and not only the investor that can’t afford whole stocks. It can be argued the dividend investors will benefit the most from the fractional shares, compared to growth- and value- investors.
The argument lies in the reinvesting of dividends received. When every single penny can be put to work and collect dividends from the fractional shares the long term benefits of the fractional shares will be major.
While this is not an endorsement of dividend investing, it has clear benefits compared to investing in the general stock market.
- Enable purchases of shares with a high price per share
- Enables investors in lower income levels to invest and build additional savings/growth
- Fully utilize money (Zero cash drag/uninvested funds)
- Receive dividends to proportion owned
When starting/learning stocks and investing it can be scary to dumb a life saving into unknown territory. Fractional shares are an easy way to start learning and understanding stocks. Imagine that you wanted to invest in Amazon but did not know about investing. Amazon has a current price of about $1.700, which is a lot if you don’t know what you are doing.
The fractional shares allow beginners and low-income earners to own parts of high valued stocks such as Amazon, Alphabet, and Berkshire Hathaway. This is especially beneficial for lower-income earners. For a relatively wealthy beginner, a minor loss can be handled, while a low-income earner will see a bigger impact total net worth if mistakes are made.
Furthermore, low-income earners grant access to saving options other than the low-interest rates offered by the banks. With a return on stocks of roughly 8% percent per year, the lower-income earners have access to wealth growing assets.
The average investor will have money in their deposit account which cannot be invested due to share price being higher than the free funds available. Fractional shares make it possible to invest all the free funds so that all money is put to work.
The single biggest reason I personally like fractional shares are the dividends paid in proportion to the fractional shares owned. When investing in many companies, the potential dividend loss could be big. The fractional shares have been for mutual funds and DRIPs for a long time. However, European stock brokerages such as Trading212 are starting to introduce the opportunity to get fractional shares.
What Is The Drawbacks Of Fractional Shares?
While fractional shares has some very delightful benefits, it also has some advantages. Just as much as fractional shares can secure some additional dividends, keep all funds invested, enable low-income earners to invest in wealth-generating assets.
- Less monetary rewards when investing lower amounts
- It is not possible to own parts of a share
- Fractional shares cannot always be sold
- Transfering fractional shares to other/new brokerage
One of the “No sh*t Sherlock” disadvantages is that investing lower amounts also results in lower monetary returns. The gain of 10% on €100 is, of course, lower than the gain of €1.000. As fractional shares encourage investors to invest lower amounts, investors can also invest in a lot more companies. While this is a benefit for the investor, it is a drawback for the company.
Whereas an investor was forced to purchase one full share at a time, investors can now invest for only €1 on brokerages such as Trading212. Companies go public to raise capital, and encouraging investors to invest smaller amounts in companies could technically minorly impact the companies.
It is not possible to own fractions of a share. However, brokerages can handle the burden by pooling together many fractions together to make full shares hereby selling you a percentage. However, they can also split up full shares to sell fractional shares to new investors.
Due to the technicality of owning fractional shares, some brokerages have limitations or restrictions on selling fractional shares. This is because the fractional shares have to be joined together with other fractional shares to create whole shares, before they can be sold.
As previously mentioned it is technically not possible to own fractional shares. Therefore, some brokerages can have restrictions or limitations on taking on transfers of stocks from other brokerages. This can be a problem if an investor would like to combine all stocks at one broker.
Verdict – Is Fractional Shares Worth It?
Looking at what fractional shares is and how they can emerge it is not a new phenomenon. However, only recently European brokers started to introduce the fractional shares to their platforms. The benefits of fractional shares are the availability of investments to everyone regardless of paygrade and investment experience.
The single biggest benefit is the additional dividend that can be received when owning fractional shares. The long-term compounding of the dividend could have a significant impact on the total value of a portfolio.
I would invest any spare cash on my brokerage account into fractional shares, as I like to have my money work for me. This way, I can receive some extra dividend and the value of my otherwise uninvested money will appreciate with 8% instead of 0%.
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