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With so many high-quality companies like Amazon and Google multiplying in value over the years, they’ve become must-have opportunities for many investors. However, as these stocks and ETFs (exchange-traded funds) go up in price, how can investors with little capital also participate? For example, throughout most of 2021, the cost of just one share of Amazon (ticker: AMZN) was well over $3,000.
In an attempt to democratize investing and break down these cost barriers, many Fintech companies are now letting users buy what’s known as fractional shares. And if you're used to using a platform like Robinhood, then there's good news for you.
Robinhood lets investors buy fractional shares from over 5,000 well-known companies and ETFs. This allows users to purchase equities based on the amount of money they have available rather than the market share price, giving these investors a wide range of options to customize their portfolios.
So, what are these partial shares of securities exactly, and is there any downside to owning them? In this post, we'll explore how fractional shares work, what investors need to be aware of, and how they can benefit your overall investment strategy.
Fractional Shares On Robinhood
If you're relatively new to investing, then you may not realize how revolutionary it is to be able to use a trading app like Robinhood and have the ability to buy fractional shares. To help you appreciate this benefit, let's first take a look back at how the industry operated up until just a few short years ago.
How Stock Buying Previously Worked
Ever since the creation of stocks, shares were only available in one form: whole numbers. For an investor to buy equities, they had to round their order to the nearest whole number with “1” being the absolute smallest amount that could be purchased. Fractional shares were simply not allowed.
To understand why you have to imagine what securities trading was like before computers. Amongst the chaos at the New York Stock Exchange, the easiest way for floor traders to manually take and fulfill orders was to work with whole numbers of stocks. There wasn’t any technology to support doing it any other way.
For the average-priced stock (less than $100), buying equities in this way wasn’t really a problem. However, as some companies would rise to dramatic new heights in price, they would start to get to a point where people who wanted to invest in them couldn’t because the asking price had become too expensive.
The classic solution to this situation was something called a stock split. This is where the company issuing the stock would “split” shares. For example, a 3 to 1 split (written 3:1) means you'd receive 3 shares for every 1 share you own, effectively lowering the stock price by one-third and making it more affordable to the common public.
It should be noted that not all companies like stock splits, and this is for a multitude of reasons. For instance, Class A shares of Warren Buffett’s Berkshire Hathaway closed above $500,000 per share in March 2022. Buffett said he intends to never split the stock because the high price attracts “shareholders who are as investment-oriented as we can possibly obtain”.
Despite the reason, it’s clear that these high prices create a huge barrier to entry for new investors. This is where Fintech came in and changed everything.
What Are Fractional Shares Of Stocks?
A fractional share just means that you, the account owner, hold less than one full share of a security. For example, if you own 0.5 shares of a stock that trades for $100, then your value is $50. If that same stock increases to $150, then you could sell your 0.5 shares for $75 and earn a $25 gain.
Technically, fractional shares are nothing new. For decades, the mutual fund industry has offered investors the ability to buy according to the dollar amount they had to invest as opposed to the number of shares they wanted.
With the introduction of robo-advisors, this became a standard way to buy large quantities of popular stocks and ETFs too. Because these algorithms were more or less making recommendations to their clients from the same pool of securities, it allowed them to efficiently place large orders for shares and then split their ownership upon receipt among their users.
This idea started to grow in popularity, and now it’s a feature that's becoming more mainstream among the majority of trading apps.
How Fractional Shares Work on Robinhood
Since 2019, Robinhood has been offering its users the ability to buy fractional shares of securities. “We have so many investors that just want to dip their feet into the market and put ten dollars in,” Robinhood CEO Vlad Tenev told CNBC. “We think this will empower even more people to invest.”
Here are the requirements from Robinhood when it comes to buying fractional shares:
- For a security to be considered eligible, it must have a share price of $1.00 or more and a market capitalization above $25,000,000. According to Robinhood, this results in a menu of over 5,000 different stocks and ETFs.
- Purchases must be for $1.00 or greater.
- Investors may buy as small as 1/1000000 of a share. To put this in perspective, this means you could buy two-millionths of a share of Berkshire Hathaway Class A stock for $1.00.
- Trading takes place in real-time (during market hours) and is commission-free.
For Robinhood’s official information about how they handle fractional shares, click here.
The Advantages of Buying Fractional Shares
Being able to buy shares of stocks and ETFs out to 6 decimal places may not seem like a big deal. But it's actually a huge step for investors for several reasons.
Traders Have Access To Expensive Stocks
First and foremost, investors can buy up stocks of their favorite companies without having to risk their entire life savings to do so.
For example, consider the following popular but very expensive stocks:
- Alphabet Inc Class A (ticker: GOOGL) – share price $2,461.48
- Amazon.com, Inc. (ticker: AMZN) – share price $2,921.48
- AutoZone Inc. (ticker: AZO) – share price $2,195.68
- Booking Holdings Inc (ticker: BKNG) – share price $2,246.04
- Chipotle Mexican Grill Inc. (ticker: CMG) – share price $1,516.00
One share of these five stocks alone would cost you a total of $11,340.68. Unfortunately for investors who are relatively new with limited capital and experience, that’s a lot to ask.
Likewise, a portfolio this large could also result in big losses. Remember: No matter how great a company is today, there’s always a chance that it could lose value in the future. What if:
- The latest product was a flop? – Remember the failed social media platform Google Plus?
- The company missed its earnings target? – Netflix’s stock slid by 35 percent in April for this reason
- There was an internal scandal or fraud? – Remember Enron or Theranos?
- An outside influence like the pandemic, war, or changes by the federal government which caused the entire market to slide?
These are all situations that can send the stock price tumbling.
Fractional shares help to mitigate the impact. For example, you might only invest $500 and buy $100 worth of each stock proportionally. Not only is this less expensive, but it also helps to diversify the risk potential.
This is huge because it means you now can add stocks to your portfolio that were previously out of reach. You could effectively create your own version of an ETF and have it include whatever companies you believe have the greatest long-term potential.
In short, investors no longer had to settle for what they could afford. They can now buy exactly the securities they want to put their money into.
Fractional Shares Can Be Good Business For The Companies Involved
Investors aren’t the only people who’ve benefited from fractional share buying. Some companies have seen an uptick in activity ever since brokerages started offering fractional shares.
For example, SoFi (another trading app like Robinhood) says fractional trades represent 35 percent of all stock buys, according to a spokesperson. Among them are some very familiar names like Amazon, Tesla, Apple, Walt Disney Co., and Microsoft.
Fractional shares are also big business for brokerages too. Even though these apps might be offering commission-free trading, they still charge a very small fee for every order that they process. One company, Interactive Brokers, saw a 131 percent jump year over year thanks to fractional shares.
It’s safe to say that if there wasn’t something in it for the companies providing this service, then they wouldn’t offer it.
Investors Still Receive Dividend Payments
If an investor is concerned that a fractional share might somehow not entitle them to receive a dividend payment, then there are no worries. Stock owners with partial shares will still receive a cut of the security’s profits.
Of course, the payment will be in proportion to the number of fractional shares you own. To illustrate here’s a simple example:
- Suppose you own a stock that’s valued at $1,000 and has a 3 percent dividend yield ($30).
- However, you only own 0.5 shares (i.e., half) of this stock for $500.
- Therefore, your dividend payment would also be half at $15.
Essentially, the brokerage is collecting these dividend payments and then splitting them amongst the fractional shareholders. Since this is all done through computers, it all happens automatically.
Orders are Fulfilled In Real-Time
One might think that because fractional shares need to be collected and sold as whole shares that there could be a delay in fulfilling orders. However, Robinhood insists orders will be fulfilled in real-time and may use some of their own inventory to help facilitate the sale.
The Disadvantages Of Owning Fraction Shares
While fractional shares have a lot of upsides, there are some concerns that investors should be aware of.
Not All Stocks Are Allowed
Recall that for a stock to be eligible for fractional shares with Robinhood, it must have a share price of $1.00 or more and a market capitalization of $25,000,000. While most major stocks will meet these requirements without question, there may be some that don’t.
For instance, investors who use “penny stocks” will not be able to include fractional shares in their strategy. Also, companies that have gone bankrupt and experienced a significant price decline below $1.00 would also not be considered eligible.
Shares Might be Slightly Discounted at Sale
Because Robinhood strives to fulfill market orders in real-time, there may be a small discrepancy in price.
Per Robinhood’s Customer Agreement Related to Fractional Shares, “Robinhood will endeavor to price such shares or fractional shares at a price between the National Best Bid and Offer (“NBBO”) at the time of the order during market hours.” Although this difference would probably go unnoticed by most investors, it's still worth noting.
Cannot Transfer Fractional Shares
In some instances, traders may wish to move their assets from one brokerage to another (usually to consolidate accounts or avoid high fees). This can usually be done without liquidating your account by using what’s called an Automated Customer Account Transfer Service (ACATS).
Unfortunately, with fractional shares, you won’t be able to do this. Investors can transfer any whole shares they own but will have to go another route with their partial shares either by liquidating them into cash or leaving them in the account.
No Voting Rights
Though it’s not typically a top priority for most casual investors, it is worth knowing that fractional shares will not give you voting rights. Typically, one whole share of stock is equal to one vote during a company shareholder meeting. However, with partial shares, voting rights will be aggregated and managed through a vendor employed by Robinhood.
Concerns About Stock Buying Into Gambling
Because of the relative nature and potential losses involved with securities ownership, it’s always been assumed that investors would make their purchases only after doing their due diligence and research. However, with the ease of trading apps, that trend may be changing
Investors, particularly younger ones who haven’t experienced significant losses or recessions, are more inclined to make speculative investments. Fractional shares allow them to take a chance on stocks they may know little or nothing about.
In the opinion of some analysts, this results in little more than gambling. You could look at it this way: Instead of buying $20 in lottery tickets or playing the casino, these people can instead buy a handful of fractional shares and sell them at the first opportunity they get.
Although this may sound harmless, it does give rise to two potential issues. The first is that more frequent trades may result in more imbalance in the market. The second is that fractional shares can be used by investors like those on Reddit who pump up so-called “meme stocks” like GameStop and AMC.
Both of these situations could be disruptive to the traditional flow of stock trading and may create dangerous situations (such as the wild price swings of some meme stocks). Investors need to be cautious.
How To Buy Fractional Shares On Robinhood
Buying fractional shares is extremely easy to do on Robinhood. If you’re already a user, then here’s how you can get started.
- Check your security. When you go to a stock or ETF you wish to buy, click Trade followed by Buy to see if it's eligible for fractional share purchase.
- If the security is eligible, then you’ll be given two choices: Buy in Dollars or Buy in Shares.
- If you choose to Buy in Dollars, then simply enter the amount of money that you’d like to spend. Remember that this purchase must be at least one dollar.
If you choose to Buy in Shares, then enter the number of shares you’d like to own. Note that any partial shares worth less than $0.01 will be rounded to the nearest penny. Also, again – purchases must be at least one dollar or more.
Should You Invest In Fractional Shares On Robinhood?
If there are stocks you'd like to buy that are too expensive, then Robinhood has you covered. One of the trading app's many great features is that it lets its users buy fractional shares of securities. This means that you'd own a fraction or portion of a stock instead of a full share.
This is a major departure from the way buying stocks has worked in the past. Up until recently, orders could only be made up to the nearest whole share with one being the minimum. However, thanks to the rise of Fintech and robo-advisors, several trading apps are now providing this service.
With Robinhood, users can buy fractional shares from over 5,000 different stocks and ETFs. Purchases must be for $1 or more and can be as small as one-millionth of a share.
The big win for investors is that they can buy shares of companies that might have previously been out of reach. This not only reduces the barrier to entry but also reduces the risk to the buy. Investors can still expect to trade in real-time and even receive dividends.
However, there are some concerns in the industry surrounding fractional share ownership. For one thing, the owner has no voting rights and cannot transfer their assets to another brokerage without liquidating these partial shares first. Some experts even believe this could lead to more investor speculation which may cause turbulence in the markets.
In the end, fractional shares are another tool that you'll have at your disposal. Depending on how you invest, you may never want or need them. But if the time comes that you'd like to buy expensive stocks and only have a little capital, it will be nice to know that the opportunity exists.