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What are fractional shares?

Normally when you want to invest your money in a stock you like, you decide how much you want to invest in that stock, log onto your broker's website and see how many shares at that price you can buy with that amount. The amount you want to invest divided by the stock price determines how many shares you can buy.

If you use robo advisors to automate your investments, M1 and Betterment are the well-known platforms for fractional share investing.

For example, if you have $1,000 and your favorite company, XYZ, is trading for $100 a share, you can buy 10 shares.

But what happens when it's trading for $100.25?

You can buy only nine shares. This is because, in the days of physical shares, it was impossible to “split” a share. But now there's no need for a piece of paper to buy stocks. So brokers have done away with the formality of whole-numbered shares, and investors can now buy fractions of shares.

In the above example, with XYZ trading at $100.25, you can now buy 9.97 shares. This allows you to enjoy more returns. And in the long term — over decades — you gain more wealth as these small differences add up.

Keep in mind that a high price per share does not necessarily mean that stock is an amazing investment. As always, do your own due diligence on which stocks and investing strategies work best for you.

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The split: where fractional shares come from

Fractional share investing is something that was impossible two decades ago. But now we see some of the biggest brokers offering it as a service. This shows just how much demand there is.

How are fractional shares made? To simplify it, when you put in an order for a fractional share, your broker actually goes out and buys the whole share. They then divvy up that share to investors who want a fraction and note the division in their books.

While fractional shares are a relatively new trend, the concept is not. Stock splits are a similar concept. They divide current shares into a multiple of new shares. While each individual stock is worth less, the total value of the shares remains the same. Companies generally do this to make it easier to invest in their stocks, something fractional shares tackle as well.

How does investing in fractional shares work?

When you open up your brokerage platform, you used to have to write in a quantity of shares you want, then the price you are willing to pay for them.

With fractional shares, you want first to make sure this option is enabled. (Some brokers may require that you request access to this feature.) After that, when you go to put in an order, instead of a quantity of shares, you should be able to input a dollar amount.

The brokerage application will then calculate exactly how many fractions of a share you will get with that amount, and you are good to go!

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Why fractional shares are a game changer

If you're just getting started with investing and have a bit of money to spare to put toward your retirement fund, you may be wondering how anyone can afford stocks like Apple, Tesla, or Amazon.

All of these companies trade at share prices in the hundreds or thousands of dollars.

But with fractional share investing, you can simply buy a slice of a share, and your money starts working for you. Even better, instead of having to wait months or years to have enough money to build a diversified portfolio, you can immediately split your funds into your favorite companies.

While the amounts may be small at first, compound interest will work its magic, and these modest contributions can snowball into something significant over years of investing.

It's also much easier to invest based on how much cash you have rather than working out how many shares you can purchase with that amount of money. Plenty of brokers and stock trading apps are making this even easier.

With fractional shares, more people are invested in the market. This leads to more interest in companies, which leads to better business governance. And everyone stands to gain from that.

Related: What Are FAANG Stocks?

Things to keep in mind with fractional share investing

The requirements are pretty simple: You need a brokerage account with funds.

Keep in mind that fractional shares have become popular in the American market but not in foreign markets. That means if you're looking to invest in foreign markets such as Europe or Japan, you may not have the option to buy fractional shares.

Further Reading: What are ADRs?

However, as the idea of fractional share investing continues to grow, so should adoption into the industry.

While perhaps not every broker offers fractional share investing at this point in time, most of the major brokerages do. Read on to learn who we think are the best brokers to start fractional share investing with!

Best fractional share investing apps

Before you jump in and start building a portfolio of your top stock picks, make sure you have a broker that offers fractional shares and suits your investment needs. For a small retail investor, this means a broker with low or no trading fees. To that end, we have a few recommendations:

Public.com

Public may seem like a new broker, but it's actually a rebranding of one of the first brokerage apps: Matador. With a sleek new application, Public looks to compete in the retail investor segment. To this end, they offer commission-free trading — meaning you pay them nothing whenever you buy and sell stocks — a highly functional mobile app, fractional share investing, and social features allowing you to build a community of like-minded investors.

Learn more

Fidelity

Fidelity has quickly emerged as one of the best all-around stock brokers available today. In addition to offering fee-free mutual funds and ETF purchases, customers can also pick up fractional shares and more. They offer a basic platform for beginner investors as well as a more sophisticated one for serious traders. Plus, their 24-hour live chat and phone lines means you'll be connected with customer support easily and at any hour.

Fidelity review

Robinhood

Perhaps one of the most well-known brokers, Robinhood burst onto the scene as the first broker to offer commission-free trading. It's managed to keep customers coming back because they have one of the simplest and most easy-to-use interfaces on the market and a determination to add new features constantly. One of those new features is fractional-share investing, as well as automated dividend reinvesting.

What Are the pros and cons of fractional shares?

Pros

  • You can start investing with very little money, and there is no barrier to entry.
  • You can buy into companies no matter how pricey their shares are.
  • Those without a large monthly income can still enjoy the benefits of dollar-cost averaging.
  • Easily build a diversified portfolio from the get-go.

Cons

  • New investors may be more reckless with their money.
  • Companies with high share prices may see their prices inflated due to all the retail investors who can now buy their shares. Stocks with inflated prices often make for poor investments. And a high price on a stock does not mean it's a good investment.
  • If you own a very small fraction of a share, your broker may keep your dividend. For example: In cases when your fraction of a stock entitles you to less than 1¢ in dividends (0.9¢ for example), you may not receive any dividend, and that portion could be a meaningful percentage of the stock's value. On a $1 fraction, you would miss out on 1% in value, and with a quarterly dividend, you would miss this four times a year.

Are Fractional Shares Worth It?

Fractional shares are worth it if you want to start investing with little money and have your eye on some expensive shares you wouldn't normally be able to buy. They're also powerful tools for diversifying your portfolio very quickly.

However, fractional shares aren't worth it if you're just using them to buy shares in large, trending companies without understanding the fundamentals of the investment. Investing in Tesla and Amazon might sound like great investments, and they very well could be. But it's important for new investors to research the stocks they're buying and to understand why those fractional shares are a good fit for their portfolios. And, as mentioned, be careful of very small stock slices since this can lead to your broker holding dividends from you.

Fractional Shares Help Democratize the Stock Market

Fractional shares allow an entirely new class of retail investors to enter the stock market for the first time. We are seeing a wave of democratization in the finance space thanks to all types of fintech companies. And this trend looks to only accelerate in the future with the advent of technologies such as artificial intelligence.

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Isaac Aydelman Freelance Contributor

Isaac Aydelman is a freelance contributor for Moneywise.

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The content provided on Moneywise is information to help users become financially literate. It is neither tax nor legal advice, is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Tax, investment and all other decisions should be made, as appropriate, only with guidance from a qualified professional. We make no representation or warranty of any kind, either express or implied, with respect to the data provided, the timeliness thereof, the results to be obtained by the use thereof or any other matter.