When investors consider stock investments, they’re most likely thinking of a whole share. As they set their eyes on US stocks which cost significantly higher than their Indian counterparts, they tend to take a step back.
This happens mainly due to two reasons – investors either don’t have enough capital to diversify their portfolio or do not want to invest their entire savings in a single company.
But what if I tell you there’s a way you can invest even in US blue-chip stocks without paying the price of a whole share?
Sounds fascinating? Let me introduce you to the concept of fractional investing.
Think of a company’s share as a whole pie.
The pie can be split into several pieces and each customer gets to take one or more of these delicious slices home.
Fractional shares are akin to the slices of a pie. A company’s stock, owing to various reasons, can be split into several fractions and you can choose to purchase only one of these pieces of a whole share. Consequently, you reap the returns from the appreciation of this particular fraction.
This way, limited capital no longer acts as a hindrance when it comes to investing in the shares of a company of the investor’s choice.
Fractional shares have garnered enormous popularity over the past few years owing to the advancements in brokerage technology.
You can, thus, invest in expensive securities and diversify your portfolio even if you have limited capital.
Let’s say the market price of a share of XYZ Company is $2,000; you’ll have to part with $2,000 to add it to your portfolio.
Moreover, if you plan on buying more of the same stock, you will have to purchase in increments accordingly.
But fractional investing allows you to buy the stock amount that’s within your financial limitations. So, you can start investing with even $1.
This feature has also granted fractional investing the moniker of dollar-based investing.
Most of the popular stocks tend to be more expensive than others. Hence, if you want to diversify your portfolio by investing in shares of each of these companies, you’ll require a massive amount of capital upfront.
This is where fractional investing can help. It allows you to apportion a certain amount of money to each of the companies of your choice.
So, for example, if you’re starting out with $4000, you can choose to invest $400 in 10 separate companies.
Thus, it enables you to diversify your investments and distribute the risk.
Fractional shares are created by way of some major decisions taken by a company such as mergers and acquisitions, stock splits and more.
Furthermore, there are many brokerage firms that enable you to invest in fractional shares.
Take a look at how these shares come about.
Stock splits may often produce an odd number of shares. Let’s say a company announces a 5-for-4 stock split. It would create 5 shares for every 4 shares owned by an investor.
Therefore, investors holding an odd number of shares will end up with fractional shares following the split.
Hence, 5 shares would become 6¼, and 7 shares would become 8¾.
Fractional shares may be formed following mergers and acquisitions as companies merge to create new stocks with a predetermined ratio.
Let’s say Raj holds 7 shares in Company B, which is merging with Company D. The companies decide to convert the shares 3-for-5 in their new company E.
Post-merger, Raj will become the owner of 4.2 shares of Company E.
Dividend Reinvestment Plans or DRIP offered by some companies, and brokerage firms often enable investors to utilise dividend pay-outs to purchase the same shares.
But sometimes the dividend amount might not be enough to purchase a full share. This can lead to the creation of fractional shares.
Here are some advantages of fractional shares –
As noted above, fractional shares make it possible for you to diversify your portfolio by investing in different companies.
By distributing your capital in the shares of different companies, you’ll be able to reduce the risks associated with the changing conditions.
Moreover, it also increases the potential of maximizing your profits in the long run.
Sometimes investing in the companies of your choice can be difficult if you have limited capital. But with fractional investing, you can eliminate this concern.
You don’t have to save up until you have enough money to buy a whole share.
For example, if the current market price of the shares of ABC Company is $800, you can buy a fraction of its share. You don’t have to wait until you save up $800!
If you plan on buying whole shares, you have to set aside sufficient capital to buy them at the targeted price.
But fractional investing allows you to set a predetermined dollar amount you want to purchase and the shares will be allotted to you.
For example, if you plan on investing $4000 worth of Company A’s stock, priced at $103.29 per share, the smallest fractional share you’ll be eligible to buy is 0.01.
So, with fractional investing, you can buy 38.72 shares of Company A. Fractional shares, thereby, allow you to buy stocks that have a high market price per share.
As mentioned previously, fractional investing doesn’t require you to risk a lot of your funds. So if you’re relatively new to the market, investing in fractional shares can be the ideal option to maximize returns.
If you have a capital of $2000, you can invest $400 in five different companies and distribute the risk.
Similar to other investment strategies, fractional investing is not free from its limitations. A few of its drawbacks include –
Since fractional investing allows retail investors to buy shares, the prices of the expensive stocks might become inflated.
Investing in companies with inflated share prices often proves to be a poor investment decision in the long run.
Sometimes, the time required to buy fractionating shares can be higher than purchasing a whole share.
Also, the tax assessments of trading in such shares can occasionally give rise to unwarranted complications.
Nonetheless, its benefits certainly trump the hindrances. This is why, fractional trading is growing in popularity with each passing day, and is quickly becoming the way forward.
So, if you plan on investing in fractional shares, make sure to confirm whether the online advisory platform or broker provides this functionality.